Get ready for crunchtime in France.
With only a few days to go before Sunday’s first-round presidential election, the polls are showing a nail-bitingly close race between four candidates, setting the scene for what could be a shake-up in European financial markets next week. Two anti-European Union candidates have a serious chance of making it into the final runoff round on May 7, raising fears this could be the beginning of the end for the eurozone.
“This remains an open contest and the result could yet serve up a far bigger blow for the European project than we saw with Brexit,” said Tony Cross, market analyst for TopTradr, in a note.
‘The result could yet serve up a far bigger blow for the European project than we saw with Brexit’
Usually a French general election doesn’t present a make-it or break-it moment for the entire eurozone, but this time its different. After a race full of surprises, a surge in the polls by far-left, euroskeptic Jean-Luc Melenchon has again reminded investors of the sweeping antiestablishment sentiment grabbing Europe and the U.S. at the moment.
Far-right, anti-EU candidate Marine Le Pen is also doing well in the polls and currently looks like she’ll get one of the two spots in the runoff. The big question is who she’ll face in the second round.
Will it be centrist Emmanuel Macron, who pollsters and analysts see as the favorite to emerge as president in May? Will it be scandal-ridden, dark horse candidate François Fillon who’s enjoyed an 11th hour rebound in support? Or will it be Melenchon, who has promised to rework the treaties that set the framework for the EU and then hold a referendum on whether to remain in the bloc.
“Investors (and French voters) are getting worried about a ‘nightmare’ scenario in which Le Pen faces Mélenchon on 7 May, leaving them with a hard choice between two anti-globalization, anti-EU and pro-Russia candidates,” strategists at Citigroup said in a note.
“The French election presents ‘volcano’ risk, i.e. strong moves are likely across financial markets but risks are very much two-way,” they added.
35% slump in European stocks if Le Pen wins
And here are the two-way risks: A win for either Le Pen or Melenchon would spark a selloff in risk assets and drive French and European equities down 5%-10% by the end of June, Citi said. However, if Macron or Fillon secures the presidency, stocks in Europe could see a 10%-20% rally before the end of the year, they said.
Over at Bank of America and UBS, the forecasts were also downbeat in case of a Le Pen Victory. BofA said a win for the National Front leader could trigger a 13%-23% slide in the Eurostoxx
while UBS forecast a whopping 35% slump for that index.
For the euro
the French election result could also have a significant impact, analysts said. HSBC strategists said the shared currency could drop to $0.90—below parity—in the case of the “worst-case scenario” of a Le Pen-Melenchon runoff.
“With the very real risk growing in this scenario that France’s next president might take the eurozone’s second largest economy out of the bloc, the euro could fall hard,” HSBC’s team said.
“This potential fall of 16% chimes with the scale of depreciation seen in other currencies in the aftermath of a destabilizing political event.”
On the plus side, the euro could rally to $1.12 if the runoff turns into a showdown between Macron and Fillon, HSBC said. The euro on Wednesday traded around $1.0717.
“If we get a Macron/Fillon second round runoff, this is likely to be considered ‘market friendly,’ triggering a rally in the euro, the [French CAC-40 stock index]
but also in the German Dax
and Eurostoxx index, which have had decent correlations with the French bond yield this year,” said Kathleen Brooks, research director at City Index, in a note.
Hedging with ‘Les Dix’
So what should investors do as the vote draws closer? With an unprecedented number of undecided voters, there’s no clear-cut result on the horizon and the Trump win and Brexit vote have showed opinion polls are difficult to trust.
The Citi analysts suggest sticking to their “Les Dix” strategy. “Les Dix” refers to 10 buy- or neutral-rated stocks that will give investors exposure to a risk-on outcome—a Macron or Fillon win—while at the same time protecting against the risks of a Le Pen or Melenchon win. That’s because they all have high international sales exposure, so would get a boost from a euro slump, Citi said.
The 10 stocks in Citi’s French hedging basket include Airbus SE
LVMH Moët Hennessy Louis Vuitton SE
Pernod Ricard SA
Publicis Groupe SA
and Valeo SA
Complacency creeping in ahead of vote
Despite the uncertainty hanging over the French election, investors seem to have an insatiable appetite for European, and French stocks in particularly.
According to the monthly Bank of America Merrill Lynch fund manager survey the allocation to eurozone equities rose to a 15-month in March, while moves into U.S. stocks plunged to the lowest level since 2008. That marks the fifth biggest rotation since 1999, according to the bank.
“The chief beneficiaries are French stocks. Sentiment has completely flipped and is now net 22% overweight [from -24% in February]. Although we agree on the allure of Europe’s earnings recovery, complacency looks extremely high,” they BofA analysts said in a note.
France’s CAC 40 index is up 2.9% year-to-date, compared with a 4.4% rise for the Stoxx Europe 600.