Skip to the content

A market-friendly result which will help reduce the European risk premium

25 April 2017

Jeff Taylor, head of European equities at Invesco Perpetual, looks at France’s recent election result and its effect on European equities.

By Jeff Taylor,

Invesco Perpetual

The essential thing needed to line European markets up for a positive reaction to the result of the first round of France’s presidential election this weekend was confirmation that one of the two main market-friendly candidates made it through to the second round of the election which takes place on 7 May.

As predicted by the opinion polls, this has duly happened. Market-friendly centrist reformer Emmanuel Macron will face far anti-European right-winger Marine Le Pen.

The nightmare for the markets, a run-off between Le Pen and hard left-winger Jean-Luc Mélenchon, will not happen. Forget a major assault on the euro project.

The narrowness of the result in Sunday’s election result is not what matters from here. The French start over again with the second round vote and there is every reason to believe that margin of victory for Macron will be far larger than a cursory glance at the first round results might lead one to assume.

Opinion polls before the weekend’s result have consistently pointed towards something like a 60-64 per cent: 36-40 per cent vote in Macron’s favour, should he face Le Pen in the second round. Initial polls on Sunday repeated this. What the French call ‘le front républicain’, i.e. basically make sure the Front National represented by Le Pen doesn’t win, is, once again, seemingly swinging into action.

In the immediate aftermath of Sunday’s vote, defeated first round candidates of significance came out in favour of Macron for the second round. Particularly important for Macron must be the endorsement of him by right-of-centre François Fillon, who made it clear in his speech acknowledging defeat that abstaining in the second round is not an option.

Other senior figures of Les Républicains like Alain Juppé also came out for Macron, as did the Socialist Party candidate Benoit Hamon and former prime minister Manuel Valls. In this context, we find the chart below from the Financial Times of interest in that it shows how pollsters believed voters will shift allegiances in the second round.

Expected voting intentions in first vs second round

  

Source: Financial Times

So, why does all this matter? We should end up with a centrist French president with a reform agenda, who is a committed pro-European and supporter of the euro. No market disruption. No reason for the (we suspect) many international investors who have a downer on Europe for political reasons to get more negative, in fact quite the contrary.

A Macron presidency should also be a lot easier for the Germans to work with constructively. Less downside risk from European politics may also nudge the European Central Bank a little closer to modifying its monetary policy in the coming months, let’s see.

Assuming Macron wins the second round, he does nonetheless have challenges to face: he has limited experience of high office and no established political party at his beck and call. He also needs to be able to work with a newly constituted French parliament after June’s legislative elections and formal or informal coalition-building will doubtless keep journalists very busy then.

But aren’t there more countries in continental Europe with more elections just around the corner? Well yes, that’s what happens in democracies. Viewed from today, Germany’s elections this autumn look pretty unproblematic from a financial market perspective. Italy is one for next year, but it is worth remembering that the country’s (very) proportional system of parliamentary representation is likely to make it hard to allow radicals any real power.

European equities have a strengthening macro-economic background to support them. With one more political hurdle cleared, we believe it is now logical that we start to see Europe's high equity risk premium, which has been in place since the financial crisis (see chart below), finally begin to moderate.

European Equity Risk Premium is still close to crisis high

  

Source: Bernstein

There is no evidence that Europe is succumbing to a wave of radical politics. Meanwhile an economic recovery is underway, inflation is returning (direction is more important here than absolute level) and European corporates are in good shape.

Europe, for all its manifold faults, deserves to be regarded better than its risk premium implies. It’s an over-used phrase, but our portfolios are by and large at the ‘risk on’ end of the spectrum and given valuations, trends in corporate earnings, the economy and politics we are still happy to be positioned in this way.

Jeff Taylor, head of European equities at Invesco Perpetual. The views expressed above are his own and should not be taken as investment advice.

Editor's Picks

Loading...

Videos from BNY Mellon Investment Management

Loading...

Data provided by FE fundinfo. Care has been taken to ensure that the information is correct, but FE fundinfo neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.