French elections could trigger rotation

My daughters have French names but can’t speak it and mine has rapidly deteriorated over the years with a lack of practice. That wasn’t the plan but at least on the weekends they have recently started to do a Duolingo French course, motivated by the gaming type format. I can see the improvement in some basic reading and writing, but the pronunciation of spoken words still leaves much to be desired! Maybe another thing to work on during Bernie’s weekends.

I didn’t plan on writing another weekend note on elections so soon, but I have begun to see a scenario where French elections have wider repercussions for a factor rotation in equity markets, and it is one of those topics where given the complexity and noise, it feels worthwhile to pull some of the discussion together.

The Facts

President Macron announced a snap election for the French National Assembly on 9 June. There are 577 seats in the National Assembly – for an absolute majority a party needs 289 seats. The Macron alliance has only 250 seats at present and has had to build support from other parties every time to pass a law, part of why Macron talks about France needing a clear majority if it is to act in harmony.

On 30th June we have the first round, which eliminates all candidates who fail to make 12.5% of the vote. Anyone who scores 50% of the vote, with a turnout of at least 25% of the constituency, wins automatically but this rarely happens (only five constituencies were won in this way in the 2022 general election). The second round on 7th July then sees the candidates left standing fight it out, though if only one candidate won more than 12.5%, or if nobody did, the run-off is between the top two candidates.

The main political parties or alliances to consider are:

• Ensemble; centrist coalition of Macron’s Renaissance party and others
• Rassemblement National (RN); far right party with Jordan Bardella as president and Marine Le Pen in charge of the parliamentary group
• Noveau Front Populaire (NFP)?; left wing alliance of La France Insoumise, French Communist Party, Ecologists, Socialist Party and other left candidates
• Union de la droite et du centre (Union of the Right and Centre)?; alliance of parties including Les Républicains (LR)

Polls and range of outcomes

Current polls have the RN winning most of the seats but failing short of a majority, with the NFP in second place, suggesting the most likely scenarios are either a minority government led by the RN or a hung parliament. The two round voting system adds complexity because as some commentators suggest, in the first round you vote with your heart (who you want in), and in the second round you vote with your head (vote against who you don’t want in). ?The most negative outcome for markets would be either the far right or left gaining majority, but given more of France is running scared of the implications of an extreme outcome, we are likely to see a surge in turnout compared to the 51% seen in the 9th June European Parliament vote, which is likely to come out and vote against the more extreme parties.

Whoever wins, Macron has said he will not resign as President, meaning potentially almost three years of “cohabitation” when the President of one party heads the state, so foreign and defence policy, while another party runs domestic policy via the Prime Minister and Cabinet. Macron decides who will lead the next government, per the constitution, but he does have to reflect the make-up of the new Assembly.

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Policy implications

Apart from tail risks around draconian taxation for corporates and individuals, and risks to EU integration, fiscal indiscipline from the right or left is what worries markets the most. Both talk about walking back labour market reforms (though interestingly RN has recently softened its tone on pension reform) and support a significant increase in public spending. Some are also concerned that a government in stalemate will not implement fiscal cuts as needed; European Excessive Deficit Procedures dictate 0.5% of GDP tightening a year until the budget deficit falls to 3% of GDP (currently ~5.5%).

However, I think RN have plenty of incentive to behave and compromise – they understand very well after the 2022 UK Liz Truss experience that markets can force their hand, and they will want Le Pen well positioned for the 2027 presidential elections when Macro can no longer run again. Marine Le Pen, in an interview with Le Figaro, has tried to reassure investors saying that she will not call for Macron’s resignation even if they win by a large margin, and that any changes impacting public finances would be preceded by a commission to review public accounts. Bardella has recently said that revisiting the pension system would not be a “near-term priority” and would rather come at a “later stage”. Italy provides us with another recent example of the bark being worse than the bite post Meloni becoming Prime Minister in 2022.

Market related thoughts

A lot of money has flowed out of France in recent weeks given the uncertainty of upcoming elections – the street has seen sizeable sell orders from US based institutions for example. This has also weighed on Europe more broadly and Cyclicals and Value, especially with increased concerns over the upcoming earnings season. I believe a chunk of that capital has flowed into Growth/US Tech and supported the recent rally – indeed per BoA we saw record weekly inflows to tech funds ($8.7bn) and US growth funds ($11.9bn) this week. I wonder if any relief around elections brings another significant factor reversal, which would likely be painful for several participants.

While there are obviously still scary tail risks in France, I do not see this as an existential threat to the Eurozone and contagion is unlikely – Italy has yet to receive €100bn of EU Recovery Fund money and will need to continue to behave fiscally for one. OAT-Bund spreads are back to levels last seen before 2017 when Euro break-up risk seemed higher, albeit hard to see them now go back to recent tights. Despite the spread widening, French 10 year OATs at ~3.2% are not materially higher than a few weeks ago, and so for now, the impact on fiscal deficits via the interest rate channel should not be a concern, especially considering France has a weighted average maturity of debt > 8 years.

The consensus view seems to be de-risk portfolios into the first round but that this then marks peak uncertainty, so buy the dip in the week between the first round and the second round. That seems sensible given what we’ve outlined so far, but the risk here is that no dip materialises after investors have lightened up. While hardly talked about yet, there is a higher probability than many are considering, of a market friendly outcome where voter turnout increases so significantly it swings momentum back towards moderate parties away from the extremes.

Arguably there is a fair bit of negativity already priced in as well given the recent de-rating. P/E multiples on the French CAC 40 Index are still below those seen during the 2017 French Presidential elections, but also consider that 9 of the top 10 members of the CAC 40 are LVMH, TotalEnergies, Schneider Electric, L’Oreal, Sanofi, Air Liquide, Airbus, Safran and Hermes. More generally I like leaning into whatever your preferred quality French exporters are on this pullback, as they will benefit from a weaker Euro and have lots of international options when it comes to optimising taxation in case of a bad outcome, yet will participate in a broader risk-on relief rally in more benign outcomes.

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Bernie’s weekend eats – Maison, Paris

Located in the 11th arrondissement, this unique and special space is meant to make guests feel like they have been welcomed into someone’s home. You step into this former coffee machine repair workshop, are welcomed by one of the friendly wait staff, before making your way up the stairs and perhaps sitting at the large wooden table in the middle of the room or at the bar in front of the open kitchen where you see flames dancing out of a wood burning oven and a wood fired grill. It’s a set menu of whatever the seasons provide, cooked simply but executed to a very high standard where the combinations make sense and are so well balanced. Chef Sota whose artistry is so impressive, was born in Japan but has been working in Paris since 2005, and prior to this was cooking at Clown Bar. The wine list is very attractively priced and has a varied selection of typically smaller passionate winemakers, many of whom the Sommelier knows. I come here every year and it keeps getting better.