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ANALYSIS: French elections – prepare for an uncertain outcome

The question here is of course which result markets have priced in. The centrist, pro-EU candidate Emmanuel Macron has been the long-time favourite of investors, and is likely to beat all other candidates if he makes it to the second round, according to polls.

Hope for the best

“Emmanuel Macron’s victory in the French presidential election would not be a surprise – but it would be a relief,” said Philip Dicken, head of European equities at Columbia Threadneedle. “It would reduce the heightened political uncertainty that has prevailed since Britain voted to quit the EU on 23 June 2016. We would expect stock market volatility to decline as political worries retreat.” 

The private sector in France seems to anticipate this outcome, as business activity in the country reached a six-year high in April, according to Markit. This comes as macroeconomic conditions in Europe are improving across the board, possibly laying the foundations for a sustained stock market rally on the continent.

 

Prepare for the worst

It’s probable that Macron will win the presidency if he makes it to the second round, and markets will respond favourably if that happens on Sunday. However, polling is close, and a large share of French voters are yet to decide who to vote for.

Moreover, Thursday’s Islamist terror attack in Paris may swing some of these undecided voters to the right. At least, that’s what some people seem to think… 

So, what if Macron fails to make it even to the second round?

That leaves three scenarios that markets do not currently expect, but are a distinct possibility. One of these scenarios is a run-off between the two anti-EU candidates, far-right Marine Le Pen and far-left Jean-Luc Mélenchon.

It’s impossible to say how likely this outcome is, but it’s perhaps larger than currently anticipated by markets. After all, Le Pen and Mélenchon together are projected to take about the same share of votes as Fillon and Macron combined.

But one thing is certain: a Le Pen/Mélenchon run-off wouldn’t be welcomed by markets, says Mark Dowding, co-head of investment grade debt at Blue Bay Asset Management.

“It could lead to some large risk-off moves on fears that the future of the monetary union could again be called into question,” he says. French government bond yields are also likely to rally in this scenario, since neither Le Pen nor Mélenchon are committed to the euro, and both want to increase government spending.

But markets should be welcoming all other five scenarios, claims Dowding, as the other mainstream candidate with a chance to reach the second round, centre-right former prime minister François Fillon, should be expected to fend off a populist challenger in a run-off. 

However, that remains to be seen. Fillon was the front-runner in the campaign until it emerged he had been employing his wife and children in fake jobs for years running, using tax payers’ money to pay them generous salaries. Considering the majority of the French public wanted Fillon to withdraw his candidacy after the scandal broke, it’s highly uncertain he will win any run-off.

It is much clearer, however, that even if he manages to grab an unlikely victory, he will remain haunted by political scandals throughout his presidency. This will leave him unable to garner the political capital needed for him to implement the ambitious economic reforms he proposes.

Read on the next page how to position your portfolios to be prepared for every outcome

 

Part of the Bonhill Group.