Legg Mason: Outsider versus outsider: Will Europhile Macron stem the populist tide?

Legg Mason: Outsider versus outsider: Will Europhile Macron stem the populist tide?

Our affiliates are looking through the short-term noise to the longer-term impact of the election on the underlying structural and competitiveness problems of the French economy, as well as the European Union.

Brandywine Global
We have limited exposure to the euro and core European bonds—a view we did not change heading into the French elections. As long-term investors, we do not have any plans to change our positioning based on the results of the April 23 election. We are only halfway through the European election cycle, and investor sentiment continues to conflict with macroeconomic factors. It will only be after these elections are over that we can let market and economic forces truly go to work, in Europe and around the world.

(…) Leading up to the April 23 election, polling suggested that the French were overwhelming supportive of EU membership and the currency. A pro-EU president could cause the euro to rally, and core European yields should rise. A Macron victory would be a boon to a risk-on environment. We would be comfortable with Macron at the helm given his career in investment banking, and as the Minister of the Economy, Industry, and Digital Affairs in the second Manuel Valls government.

Martin Currie From Michael Browne, portfolio manager:
We have seen investors avoid Europe due to the risk of “Frexit” brought by Le Pen. We have argued this is unlikely, even if she did take power, and yesterday’s result makes it even more unlikely. But even if, as expected, Macron wins in the second round, we will have to wait for the Assembly elections in June to see what sort of government we will face. It seems likely that the machines of the Republican party will fire up again and split France down the middle, leaving no party with a majority – leading to a coalition. We are in for a period of co-habitation the likes of which has never been seen before under either Francois Mitterrand or Jacque Chirac.

This suggests that the ability to pass new radical laws is quite low, so major reforms are unlikely at this point. The markets may not mind this, but it would allow the extremes of French politics to argue exclusion and does not settle the problems that concern the voters of the far left or far right (who comprised 40% of first round voters).

The real sell-off will be in bonds, with spreads between France and Germany narrowing, and the possibility that the ECB can move from a negative deposit rate to flat, or reduce quantitative easing sooner than expected. This is very bullish for banks, where we are positioned and may add to that position. We are bullish on European equities overall, with this positive result, alongside the strong economic data and the start of a good reporting season, setting the scene for a positive second half of the year.

Western Asset ManagementFrom Andrew Belshaw, head of investment management, Europe:
The risk premium built into French bond spreads over the last three months has begun to unwind. Periphery spreads, particularly Italian, have also compressed, having had widened with France in recognition of the threats posed to the future of the Eurozone by the candidacies of Le Pen and Melenchon. The safe haven bid that German Bunds attracted has similarly unwound. France – German spreads have narrowed to +50bps from a high of +80bps a week ago. Italy – German spreads have narrowed to +175bps from a high of +200bps a week ago. In yield terms (10-year), France dropped 10bps and Italy 6bps, while Germany rose 9bps.

Given the relative stability of the polls since February, we have been of the view that Macron and Le Pen would be in the final round with the former as the winner. However, the economic programmes of both are such that, in our view, the underlying structural and competitiveness problems of the French economy will not be adequately addressed by either. Consequently, we believe French spreads should trade in the region +50 - +60bps against Bunds, not the +20 - +30bps that was prevalent until the fourth quarter of last year. After today’s move, spreads are now at fair value at best.

The second round is on Sunday May 7 and scope remains for volatility in French assets over the next two weeks. Medium term the focus will shift to the Assembly elections, the first round of which is on 4th June, followed by the second round on 11th June. The fact that Macron and Le Pen both lack the support to form an administration in the Assembly suggests co-habitation may prevent any radical policies being enacted. This reinforces our long-term negative view on French assets.


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