Comment from BlackRock Investment Institute
Key views:
We could see moderate gains in risk assets, with Macron’s victory largely priced in after his first-round win
Legislative elections in June will be a key yardstick of Macron’s ability to form a coalition to advance his reform agenda
We are positive on European shares, and see the reduction of political risk helping investors to refocus on the region’s improving growth prospects
“Independent centrist Emmanuel Macron has prevailed over the far-right Marine Le Pen in the final round of the French presidential election. Macron’s comfortable win of about 65% of the vote marked a rebuke of Le Pen’s Front Nationalparty, which ran on a nationalistic platform that included a referendum on leaving the European Union.
“We expect the focus to shift to French legislative elections in June. These will be crucial for determining Macron’s ability to implement his economic program, which includes labor market reforms that would make it easier for French businesses to hire and fire. We see scope for a mild risk-on reaction to the result, which looks mostly priced in after Macron clocked a first-round victory and polls consistently showed him ahead by a large margin.
“We are positive on European shares and see potential for renewed investor inflows as focus returns to the region’s improving growth. European purchasing managers’ indexes point to the strongest economic activity in six years. Europe stands to benefit from global reflation, and we see attractive valuations in cyclical shares. We are underweight European fixed income. The region’s improving economic outlook may spur higher bond yields and wider credit spreads –especially if markets sense the European Central Bank (ECB) is moving toward winding back its asset purchases.
“Macron will form an interim government for the short period until the new National Assembly is in place in July. This government is not expected to make significant policy decisions, but appointments will be a gauge of Macron’s ability to attract high-profile names from the two major parties to form a broad-based majority.
“Our base case is that Macron will need to select a compromise prime minister and cobble together a working majority with supportive members of France’s two major parties. This could lead to some watering down of his reform plans. Yet Macron’s comfortable win means we now see some chance his EnMarche! movement and its formal allies could win an outright majority, enabling him to choose his prime minister and government. A lower-probability scenario we see is the Les Républicains conservative party winning a majority. The last two scenarios would allow for business-friendly reforms –and would be welcomed by markets, we believe.
“The French election result confirms our view that markets until recently had overstated European political risks. Italian political risk and the country’s fragile banking system could move back into focus soon, however, particularly if the likelihood of early elections in late 2017 rises. These issues as well as Europe’s still incomplete banking and fiscal union leave fault lines that could be exposed by eventual ECB normalization –and which bring into question the longer-term sustainability of the European Monetary Union.
“Macron’s win marks a sea change in French politics. He is not part of the mainstream left/right parties that have dominated since Charles de Gaulle formed the Fifth Republic nearly 60 years ago. Macron, a 39-year-old former investment banker, ran on a “change” platform that would favor business-friendly reforms and deeper European integration. He is committed to meeting the EU’s 3% deficit target, combining spending cuts with targeted investments and freeing up the labor market.”
Adrien Pichoud, chief economist at SYZ Asset Management: This time, the polls were spot on, and Emmanuel Macron was duly elected President of France, as predicted by the outcome of the first round of the elections. France thus chose a President in favour of the continuation of the European project and deregulation of the French economy to be at the helm of the country for the next five years. This result dispels the risk of a further blow being inflicted upon the European Union after Brexit – damage that might, this time, have been fatal given the key role played by France in building and promoting the European endeavour.
Political risk dispelled
This election therefore serves to dispel, at least for some time, the political risk that has weighed down European financial assets for the past year, with the succession of elections in the United Kingdom, Italy, Netherlands and now France. The forthcoming German elections this autumn do not pose the same fundamental risk for the future of European institutions and the single currency. And the main bone of contention of the next parliamentary election in France is no longer the prospect of France eventually leaving Europe, but rather the capacity of the new President to deploy his political programme. The outcome of the French parliamentary elections and the German federal elections will influence the development of European policies over the coming years, but should not affect the institutional framework of the EU and of the euro.
Focus will now shift to fundamentals
Investors can now turn their attention to the economic fundamentals of European financial assets. And in a context of positive but moderate worldwide growth, the Eurozone is showing a positive dynamic linked to the fact that it is still in the middle of the growth cycle begun in 2013. In the 1st quarter of 2017, the Eurozone’s GDP growth exceeded that of the US, as was the case for the year 2016 as a whole. The deflationary fears are dissipating and this is fuelling a debate over a gradual phasing out of the ultra-accommodating monetary policies put in place by the ECB over the past few years. Under these circumstances, the coming months should witness significant movements on the financial markets, even though the immediate impact of the election of Mr. Macron is expected to be limited, given the extent to which the markets had already anticipated this outcome pursuant to the first round.
Euro strengthens as existential risk diminishes
With the lifting of the “existential” risk posed by the French elections and the prospect of a gradually less accommodating ECB, the single currency is likely to strengthen, particularly against the US dollar should the Fed lower its ambitions owing to the US economy’s display of less dynamism than expected.
European subordinated bonds show attractive yield prospects
The prospect of a gradual ending of the ECB’s quantitative easing, in light of the positive economic growth of the Eurozone should cause European long-term interest rates to ease upwards, in particular the rates in Germany, which, until the outcome of the French elections, had somehow acquired a status of safe haven. The government rates of France, Italy and Spain might, for their part, benefit from a reduction of the political risk premium and rise in turn, but to a lesser extent. In the corporate bonds sector, European subordinated bonds are showing attractive yield prospects, thanks to the dispelling of the risk of an unravelling Eurozone. Furthermore, the positive impact of a rise in rates on the profitability of the banks, offers the prospect of a narrowing credit spread.
Equities: domestically-orientated sectors set to benefit
European equity markets should benefit from the dispelling of the political risk premium over the coming months. But not all the sectors. Financial stocks and those oriented towards the European domestic market will be the main beneficiaries of the current economic dynamism and their valuations should begin to recover. On the other hand, enterprises with significant exposure outside the eurozone might be penalised by the strengthening of the single currency.
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