Following the first-round results of France’s presidential election, the world is anxiously anticipating the outcome of the final round on May 7. Although the majority of polls point toward centrist frontrunner Emmanuel Macron winning by a wide margin, some investors, taking heed of lessons learned in last year’s U.S. presidential election, do not believe a Macron win against right-wing National Front party candidate Marine Le Pen is a forgone conclusion. Most, however, do.
In fact, in the days following the first-round results, French markets rallied. Spreads between French and German bonds, which began widening last November, narrowed considerably while the French stock market index, the CAC 40, rose nearly four percent.
“Of note,” says BlackRock’s iShares investment strategist, Tushar Yadava, “our French equities ETF, EWQ, just had the second largest week in terms of primary market activity and the largest week of trading volume ever in its 20-year history.”
The iShares MSCI France ETF (EWQ), which provides exposure to large- and mid-sized companies in France, saw its performance improve from 12.86 percent at the end of March to 16.55 percent a month later.
Breathing this collective sigh of relief, though, is worrisome as the markets appear to be underpricing the possibility of a Macron defeat. Instead, investors should be pondering the following question: What if Le Pen wins?
Insulating investments from the incredible shock of a Le Pen victory is a huge hurdle. “The markets have clearly priced in what the polling data is telling them,” comments Yadava. “Since the polls were fairly accurate for the first round, the markets are taking the second-round data of a Macron victory with a lot more weight. A Le Pen win would be a big surprise.”
David Zahn, head of European fixed income at Franklin Templeton, agrees and notes that the market is probably underpricing the risk of a Le Pen win. “If that were to happen, a risk-off scenario would follow,” he says.
And what is that scenario? “French bonds would go down,” Zahn predicts. “All credit, including the periphery [countries such as Italy and Spain] would widen versus Germany, which would become the immediate safe haven. Longer-term you could see some spillover to other bond markets such as the U.S., as investors look for safe havens.”
Yadava, who also would expect a bond sell-off, notes that investors would broadly view a Le Pen win as negative for risk assets. “European stocks, and French stocks in particular, would reflect that negativity,” he says. The euro, in addition, would take a hit as Le Pen’s stance on existing the European Union would weigh on the currency.
Where should investors turn?