“Making a call between equities and bonds depends on how much volatility is embedded in them,” opines Yadava. “The European Central Bank is still a very big buyer of European debt so there may be some stop in place as to how far spreads would widen. Equities, on the other hand, may have some speculative positioning or protection that could get triggered, causing higher volatility in the near-term.”
Turning toward the fixed-income safe haven, German bonds, could at the very least provide protection should the unlikely event of a Le Pen win pull down French bonds. The ProShares German Sovereign/Sub-Sovereign ETF (GGOV) invests in euro-denominated German investment grade sovereign or sub-sovereign bonds.
“German bonds are a safe haven because when comparing the French and German economies, Germany is fundamentally much stronger,” Zahn says. “France runs a big current account deficit, budget deficit and relatively high debt-to-GDP. Germany’s modest debt-to-GDP and budget and current account surpluses makes it much more enticing for bond investors.”
Le Pen’s stance on splitting off from the European Union concerns investors. Although a separate event from the presidential election, a Le Pen victory could trigger the markets to price in a split from the EU. However, in the unlikely event of a surprise win, and in the even more unlikely event France votes to leave the EU and causes a hypothetical collapse of the euro, German bonds would still fare well.
“The new German currency would appreciate, and by owning German bonds you would get bonds re-denominated in that stronger currency,” Zahn says.
On the equity side, higher volatility may not be limited to just French equities but could affect all European stocks. The ProShares Ultrashort FTSE Europe (EPV) fund is used to express a negative view on European equity markets. This inverse ETF goes up if European markets go down, and it seeks a return that is two times the inverse return of the index. In simple terms this means if the index declines 1 percent, the fund goes up two percent.
Betting against the euro is another play for investors. Thomas Verbraken, vice president and a member of MSCI’s risk and regulation research team, modeled a scenario where the euro could weaken 14 percent against the U.S. dollar if the market places a high probability on France exiting the EU.
VanEck’s Market Vectors-Double Short Euro exchange-traded note (DRR) can help investors take advantage of this scenario. DRR, which makes a bet against the euro, appreciates if the euro declines relative to the U.S. dollar.
Le Pen winning the presidency is an unlikely event according to the polls and markets. Furthermore, even with a Le Pen victory, the likelihood that French voters approve an exit from the EU is even lower. But none of these are zero probability events. So proper preparation could save portfolio returns.
“The political risk premium has a very strong effect on the market,” warns BlackRock’s Yadava. “Surprises get quickly priced in and that quick pricing process is generally quite painful.”