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Global Top Cat

French Elections and European Markets

By Yiannis G. Mostrous, on Apr. 23, 2017

Here’s a timely excerpt about the French elections and European markets from an article (Europe: Enter France) that Capitalist Times Premium readers received in March. For early, timely analysis and investment ideas, subscribe to Capitalist Times Premium!

Results from the recent Dutch elections removed one engine of political uncertainty in the eurozone when the far-right populist candidate Geert Wilders didn’t win first place. That said, this year’s political calendar remains full of obstacles with the two main EU members also having elections.

France holds the first round of its presidential election in a little over a month [ed. French elections were held Sunday, April 23, about a month after this article was first published.]. And in the case of no absolute majority, the second round will be in early May. The month after features French legislative elections.

Germany holds elections Sept. 24. And Italy is due for an election in early 2018, although it could happen earlier.

Returning our focus to the French election: The National Front party of Marine Le Pen should top the first round and be defeated, most probably by the independent center-right candidate Emmanuel Macron, in the second round. With Le Pen expected to win 40 percent of the vote in the second round, the far left will have voted for her on the basis of anti-Europeanism and not economic reforms.

Le Pen is a populist politician and an experienced one, having held office for around twenty years. Her economic agenda is left to far left, and then there’s her anti-euro and anti-immigration rhetoric. The latter has been her main weapon during the election campaign.

Investors rightly worry that a Le Pen victory could change the euro picture overnight and cause initially hazardous reaction (e.g. European stock markets fall 20-30 percent). Other regions won’t escape such a sell off. Remember that the S&P 500 fell close to 20 percent in May 2011 when fears of Greece exiting the eurozone surfaced.

Our view is less alarmist. In a system where the candidate needs 50-plus percent to be elected, it’s extremely difficult to cover such a gap and win outright. Unless the entire French left votes for Le Pen in the second round (which is not our base case), the mainstream candidate should win in the end.

European Upside

A consequence of Europe’s political uncertainty is that although economic indicators are improving, and the eurozone economy remains relatively resilient, investors are unwilling to put money in its stock markets. This is seen in the region’s investment outflows.

Among those improving economic indicators is Purchasing Managers’ Index, a measure of the manufacturing sector’s health, which is pointing toward growth. European domestic demand is trying to catch up with other developed economies like the US and Japan. And it’s doing just that, with eurozone GDP growth around two percent, if not higher, this year.

A weaker euro also helps the European economy, especially when combined with demand pickup in other parts of the world. This is starting to be seen with exports picking up. Helping is the fact that banks are lending again, with loans to small- and medium-sized companies increasing. This is particularly important to the region, because more than 70 percent of lending is done via banks in Europe.

Eurozone PMI

The economic improvement in Europe is by no means isolated. The global economy continues to surprise on the upside, and a lot of leading indicators around the world are surging higher. An upbeat second quarter in the US, continued strength in Asia and no political surprises in Europe will bring the global economy one step closer to a yearly growth rate of 3.0 to 3.5 percent.

(Click to enlarge.)

On the market front, European equities trade at deep discount to those of the US. And almost all metrics indicate that the macro picture is much better than at any time in the past two years– political uncertainty notwithstanding.

Note that fiscal policy remains accommodative in the eurozone, as well­­­—yet another positive for stocks.

Financial stocks are the best way to profit from the eurozone’s potential upside. European banks, in particular, are currently experiencing positive earnings and dividend momentum. This latter dynamic is the strongest it’s been in eight years.

The ECB should make its first rate hike sometime next year. This increase will be the final catalyst for better bank earnings and commence a new cycle of higher earnings expectations by the market.

European bank shares still trade at reasonable valuations of 1.1 times price to tangible book value, which is still a discount to the market.

French, Spanish and Italian banks are the most geared to benefit from rate normalization in Europe. French equities are of particular interest, because their valuations fall well below the rest of Europe.

CT: market fasts; portfolios

The French economy is key, and its improvement will boost the rest of Europe. It’s gradually grown again and could continue to grow by two percent this year–up from one percent in 2016.

French business-sentiment indexes have picked up and so has French consumer confidence. The latter is considerably important in France, because it’s the most closed (excluding intra-European trade) major economy in the world.

That said, France has one of the largest exposures to European domestic demand, second only to Greece. As this demand recovers, the French economy benefits.

Consumer confidence has been resilient, even as political uncertainty has risen. This suggests that household consumption should pick up further.

Additionally, loans to French households expanded by 4 percent in 2016 compared to 3.4 percent for the eurozone. Corporate loan growth has also been on a steady upward path.

(Click to enlarge.)

In the full article, readers were encouraged to look at European financials a play on these dynamics. If you subscribe to Capitalist Times Premium, you receive access to the entire archive of articles, including Europe: Enter France.

Yiannis G. Mostrous contributes his expertise in emerging markets and international equities to Capitalist Times in his Global Top Cat columns.

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