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Weighing the French Election

The first round of voting in the French presidential election was held on April 23. On May 7, a runoff election will be held between the two top candidates, the far-right Marine Le Pen and centrist Emmanuel Macron, to determine France’s new president.

Markets have been unsettled as investors contemplate the possibility that the leadership of France, which is one of the two key member-nations of the EU, will come to be ruled by a leader (Le Pen) who rejects the entire European experiment.

We all know that financial markets despise uncertainty. Especially when it comes to unexplored processes like breaking up the European Union.

Right now, the financial narratives sound something like this:

♦  A Le Pen victory will lead to the end of the European Union as we know it, France’s withdrawal from NATO’s unified command, a decline in the euro, and doom for European Union economies.

♦  On the other hand, if Macron wins, the second largest economy in the European Union will have cast a vote of confidence for the Eurozone. Macron’s 60/40 polling edge is credited for the rally in the euro and European stocks after the first round of voting.

However, with recent incorrect predictions about Brexit and the US presidential election, one has to wonder: Will pollsters get it wrong again when it comes to the French election? And even if they do correctly predict the winner, will they be right about the effects of that victory?

Not only did pollsters get it wrong about the results of the Brexit and US presidential votes, most pundits were entirely wrong about the reaction of the financial markets to Britain’s exit and Trump’s victory:

♦  Investors feared the worst after Brexit, but after a sharp initial decline, London’s FTSE 100 stock index rallied strongly, and last month it set an all-time high.

♦  Trump’s win was supposed to send markets downward, but US equities reached historic highs between November and March, extending an already overheated run.

So, to paraphrase Donald Rumsfeld, we face two known unknowns in France. Who will win, and how will the markets react?

We talk a lot about the idea of anticipated events being “priced in,” meaning that what the market already expects won’t move the market if it actually does happen. After worrying France’s runoff would match the far-left candidate Jean-Luc Melenchon against the far-right candidate Le Pen, with ruinous results for the Eurozone regardless of who won, France now has a choice between the center and the far-right, with polls favoring the center. Cue the market rally, which has carried the French CAC 40 Index 4.5% higher, and pulled the rest of Europe in its wake.

We’ve been overweight Europe for almost two years, and this rally is serving our clients well. While our direct exposure to French equities represents only about 2.8% of our allocation at the Moderate Risk level, our overall exposure to quality overseas companies is meaningful. As always, we prefer to spread risk broadly, by owning small portions of a very large number of companies.

Recently European equity valuations have been cheaper, both in relation to those nations’ GDPs and in relation to US equity valuations, than at any time in the last 46 years. Any combination of higher European economic confidence or a weaker dollar, both of which we’ve seen lately, are good news for our portfolios.

What if Le Pen confounds expectations, just like Brexit and Trump, and earns an unexpected victory by picking up support from far-left voters? That is a known potential outcome, but we would still be left with the unknown of the market’s reaction. Would Le Pen, like Trump, gradually abandon one inflammatory campaign promise after another, perhaps in response to unsettled markets?

This brings us back to the realm of pure speculation, which is almost always fruitless for investors. We believe that, as wealth managers, we are paid to be neutral in applying politics to portfolio decisions, and required to remain dispassionate in the face of market tumult. As we said after Brexit, even before it became clear the expected market crash was only short-term:

Our strategy is built to withstand the inevitable volatility of the markets, and even if we had a crystal ball that allowed us to know the outcome of the Brexit [now, French presidential election] vote ahead of time, we would not change course.

We’re also privileged to be able to offer the unique perspective of TGS advisor Audrey Libois on these current events. As you may already know, Audrey is a French native. Her thoughts:

I happened to be in France for the first round of voting, when nationalist Le Pen made it to the second round. It wasn’t a surprise. Pollsters had been predicting that Le Pen would survive the first round, to the point that the only unknown commentators were talking about was who would be running against her. In fact, I was at a wedding the day before the vote and the topic came up several times, but never in a heated way. Everyone acknowledged what was about to happen, complained about how terrible the whole campaign had been, then moved on.

This, to me, is the saddest part—how ordinary it feels. I was 16 years old when Marine Le Pen’s father made it to the second round in 2002. Almost everyone I knew went to protests to rally against him. Everyone was astonished when he survived the first round, even those who had voted for him. Every other candidate who had been in the first round asked that his or her supporters vote for Jacques Chirac, who won the second round with 82%.

This time is different. I don’t think Marine Le Pen will become president, and neither do my friends and family. It’s doesn’t seem to be a close call like Clinton v. Trump. But then again, a lot can happen in two weeks. 

 One thing that most American investors probably don’t know: French parliamentary elections in June are actually rounds three and four of the presidential election. Even if Macron wins, he may not have a parliamentary majority because he is not backed by a political party. This means that his prime minister and government may be from the Socialists (unlikely), the Republicans (very likely) or the National Front. French local elections are very different from the presidential, and to me, that means we won’t truly know where we’ll stand for the next five years, until the politics get sorted out.


By James S. Hemphill, CFP®, CIMA®, CPWA®/ Managing Director & Chief Investment Strategist and By Audrey Libois, CFP® / Financial Advisor

Jim has been a CERTIFIED FINANCIAL PLANNER™ professional since 1982. Jim specializes in complex wealth transfer and retirement transition strategies and coordinates TGS Financial’s investment research initiatives.

Audrey holds the CFP® designation and particularly enjoys creating custom strategies for important life transitions.

 

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