The unexpected turn of the French elections: investment ramifications

ollowing the result of the European elections on June 9, French President Emmanuel Macron announced snap parliamentary elections to be held on June 30 and July 7. In this paper we analyze the different political scenarios that are emerging, the first reactions of the financial markets, and conclude with the impact on our investment strategies.

The rise of political uncertainty in France

The dissolution of the National Assembly (Assemblée nationale) in June surprised almost all observers and generated great uncertainty over both the result of the election and the program of the next government.

First, let us recall the few facts that are known. French elections are held in 577 local constituencies and over two rounds. The first round will have many candidates from different parties, whereas the second ‘run-off’ round is held between the top two candidates, plus possibly an additional candidate who must obtain at least 12.5% of the voters registered in the constituency. The assembly elected on July 7 will sit for at least one year, the president's power of dissolution being suspended for 12 months.

The snap election for the National Assembly does not affect the mandate of the President of the Republic (Presidential elections are for a 5-year term, separate from the assembly). However, the President’s powers are considerably reduced if his party does not have an absolute majority in the Assembly (whereas it was the case in 2017) or a relative majority (whereas it was the case in 2022). If a party other than the President's forms a majority within the National Assembly, it becomes the government and its head, the Prime Minister, has control over the country's economic and social policy. This so-called situation of cohabitation occurred after the parliamentary elections of 1986, 1993 and 1997.

There are three main blocs clashing in the upcoming vote: the outgoing centrist presidential majority (ENS), an alliance of all left-wing parties (NFP), and the far-right National Rally (RN) which won the largest share of votes in the recent European elections. Note that other candidates are possible, notably the right-wing Republicans (the party of former president Nicolas Sarkozy). National polls at this stage give 33% to the RN, 28% to the NFP, 18% to ENS and 5% to the Republicans.

However, the voting system makes the transition from voting intentions at the national level to projections of seats in parliament very uncertain, as illustrated in the graph below which gives the percentages of votes obtained in the first round and the distribution of seats to the National Assembly in 2017 and 2022.

The most likely scenario for each second round should see an RN candidate and a candidate from the three other parties confront each other. However, with the average participation estimated by polls at 63%, the qualification threshold for a third candidate is around 20%. It is likely a number of constituencies will see a three-way contest (unlike 2017 and 2022).

Finally, this political uncertainty has amplified an already significantly deteriorated public deficit situation, with the European Commission having announced on June 19 that it was considering an excessive deficit procedure against France (as well as 6 other EU countries).

The initial reaction of financial markets

The markets, like political analysts, were taken by surprise by the announcement of early elections. The reaction focused on the Eurozone markets and more particularly French securities.

From June 7 to 18, the euro lost around 1.5% against the dollar and the Swiss franc. Eurozone stocks fell by 2.8% while the rest of global stocks rose by 2.4% (in euros) and the S&P 500 by 3.3% (in euros). The decline was more pronounced on the CAC 40 (-4.6%) and banks in the Eurozone (-5.9%), with French banks being the most affected.

The most significant reaction, illustrated by the graph below, was the widening of around 30 basis points in the 10-year OAT/Bund spread to 0.76%, the highest level since 2017, even if we remain very far from the levels reached in 2011/2012 during the peripheral debt crisis. Also note that this spread remains lower than its BTP/Bund equivalent (1.02%). This is the key variable to monitor, since the common currency prevents the reassessment of geographical divergences within the Eurozone. However, unlike the depreciation of the currency, which at least has the benefit of boosting exports, the rise in financing costs in a low-growth economy only has disadvantages and increases the risk of recession.

French Government Bond spreads have widened vs. German

Impact of election results

There are four likely possibilities to consider

1) Macron’s Party is returned to power

The outgoing presidential majority is renewed in its current form or in a slightly enlarged coalition, a scenario which would undoubtedly be favored by markets, but which is clearly less likely at this stage.

2) An NFP (left coalition) majority

Given their economic program dominated by the radical left, the market reaction will be strongly negative

3) A RN (Far-Right) Majority

The economic program of the National Rally fluctuates, its candidate for the post of Prime Minister has already, on the verge of a possible victory, begun to backtrack on his most costly measures. However, a majority RN would likely result in a worsening of deficits and protectionist measures which would be clearly unfavorable to free trade agreements. The comparison is sometimes made with the Italian government of G. Meloni, however this seems superficial to us.

Though the historical origins of the RN and Fratelli d'Italia are similar, the situations differ: in Italy, a coalition of the right and far-right is in power, its program is pro-business and Atlanticist (pro-US), the country has already experienced budgetary crises and is today one of the big winners of European support policy. The risk of a significant deterioration in the OAT/Bund spread in the short term would therefore be likely.

4) A Hung Parliament

Somewhat surprisingly, this is the scenario generally put forward by polling institutes that use seat-by-seat projections even though this scenario has to date never occurred with the current parliamentary voting method in France. In this case, we could expect a technical government which handles current affairs, if we again refer to the Italian example. But given the radicalization on both the right and the left of the political landscape and the already tense budgetary situation, it seems to us optimistic to count on a return to calm, especially since major electoral deadlines will be looming in 2027 at the latest.

Our investment strategies

Most of the strategies offered by iM Global Partner have little or no exposure to the French stock and bond markets and it is always difficult to change portfolios in a politically uncertain period. However, some strong themes emerge with one key word - diversification.

In terms of equities, international diversification for investors in the Eurozone is essential. France is a key country in the Eurozone and political uncertainty coupled with increasingly constrained budgetary room for maneuver is likely to last. Wall Street, the Tokyo Stock Exchange and emerging markets today hold many opportunities for our Partners Polen Capital , Scharf Investments, LLC and Trinity Street Asset Management LLP . Even within European stocks, the volatility that should dominate once the election results are known should benefit stock pickers such as Zadig Asset Management .

The liquid alternative strategies of our Partner DBi which have proven themselves, particularly over the past 3 years in terms of diversification of strategic allocation, are also to be considered.

Finally, in our opinion, the clearest opportunity for European investors lies in bond portfolios. Unlike their equity counterparts, they are very often mainly invested in issuers from the Eurozone, sovereigns and corporates, and therefore very exposed to a repricing of political risk, especially since the financial sector represents 40% of the bond market. A diversification strategy with limited risk and almost zero (or even negative) cost is to replace part of these existing bond holdings with US corporate bonds of intermediate duration (approximately 4 years) hedged against foreign exchange risk.

The graph below compares the evolution of interest rates for US Corporate bonds with German and French sovereign rates and its equivalent for corporates in euros. The US Core Plus strategy, managed by our partner Dolan McEniry Capital Management, LLC, is particularly well suited to implementing this approach before the results of the French snap elections.

US credit hedged into euros: an attractive alternative to European bonds

Disclaimer

This presentation is intended to professional investors only, by iM Global Partner SAS (hereinafter "iM Global Partner"), a French company domiciled at 20 rue Treilhard, F-75008 Paris (France), supervised and authorized by the Autorité des Marchés Financiers under number 6925760 as a portfolio management company.

The information contained herein is being furnished for discussion purposes only and may be subject to completion or amendment through the delivery of additional documentation. This presentation does not constitute a solicitation, offer or recommendation to buy or sell any security or other financial instrument or product. Furthermore, any reference to a specific security in this document should not be construed as a recommendation or investment advice. This is not a contractually binding document, or an information document required by law.

Furthermore, the information contained herein (including historical prices, flows or values) has been obtained from sources that iM Global Partner considers to be reliable; however, iM Global Partner makes no representation as to, and accepts no responsibility or liability for, the accuracy or completeness of the information contained herein. Such information is presented as of the date and, if applicable, time indicated. iM Global Partner does not accept any responsibility for updating any such information. It may be revoked or changed without prior notice.

The information contained herein on past performance should not be taken as an indication or guarantee of future performance, and no representation or warranty, express or implied, is made regarding future performance. Performance is calculated in the unit currency and, when investments are made in a different currency, it may also be affected by fluctuations in exchange rates.

Any projections, valuations, and statistical analyses contained herein have been provided to assist you in the evaluation of the matters described herein. Such projections, valuations, and statistical analyses are subject to unexpected risks and uncertainties, are not to be viewed as facts, and should not be relied upon as an accurate representation of future events. Accordingly, no representation or warranty, express or implied, is made regarding future events.

iM Global Partner is not an adviser as to legal, taxation, accounting, regulatory or financial matters in any jurisdiction and does not provide any advice on any such matter. Investors are advised to consult their legal, financial or tax advisors before making any investment decisions. Tax treatment depends entirely on the financial situation of each investor and may be subject to change. It is recommended that investors obtain the appropriate expert advice before taking any investment decisions.

Any investment program involves a high degree of risk and is suitable only for certain investors. iM Global Partner makes no representations as to the suitability of any of the strategies mentioned for any investor. You acknowledge that you will conduct your own independent financial, business, regulatory, accounting, legal and tax investigations with respect to the accuracy, completeness, and suitability of this information, should you choose to use or rely on this document, at your own risk, for any purpose.