Marine Le Pen, the leader of France's anti-EU, anti-immigrant Front National, has a 30 per cent chance of becoming France's next president, according to bookmakers. With French voters set to take to the polls next month, should investors be worried?
Le Pen, who is widely expected to make it through to the second round of the presidential election in May, has promised to devote her first six months in office to achieving a French exit from the single currency.
Thus far one might think equity investors are not losing sleep about this prospect. In December French stocks experienced net inflows for the first time since January 2016, according to EPFR Global data, and the inflows have continued into 2017. France’s Cac 40 has participated in the global market rally, enjoying a double-digit percentage advance over the last three months.
However, an advancing equity market does not necessarily mean that investors are not nervous. The Cac 40 is dominated by multinationals that make most of their money outside of Europe. Some analysts argue that many of those companies could see their share prices rise in the event of France deciding to leave the euro, in the same way that sterling weakness in the aftermath of the Brexit result boosted the profits recorded by UK multinationals.
Irrespective of that argument, there have been many other indicators of investor concern.
Investors have “severely de-rated” European stocks with a high exposure to France, Barclays analysts noted recently, despite the fact that French economic data has been unexpectedly positive of late. Nor is this concern confined to France, with Barclays finding a similar de-rating evident among stocks with a high proportion of exposure to the euro zone.
Investors intend to reduce their exposure to French stocks over the next year, according to Merrill Lynch’s most recent monthly fund manager survey, which found that sentiment towards France was at its lowest level for almost two years.
The cost of options offering downside protection in the event of Cac 40 declines hit a five-year high last month relative to the broader Euro Stoxx 50. Similarly, French bond yields relative to Germany have spiked, with the yield gap last month hitting its highest level since the sovereign debt crisis in 2012.
The cost of insuring French debt against default, as measured by five-year credit default swaps, last month hit its highest point since 2013.
Risk premiums have fallen in recent weeks, reflecting investor relief following polls that have cemented centrist candidate Emmanuel Macron’s frontrunner status, but the ever-changing political fortunes of the main challengers mean financial markets are not likely to stop paying attention any time soon.
However, even prior to the recent dip in Le Pen’s polling numbers, markets regarded her chances of victory as remote. There’s good reason for that sanguinity. While Le Pen may well top the poll in the first round of voting on April 23rd, opinion polls have continually shown she would be defeated in the second round runoff, when voters will opt for one of two candidates.
Sceptics point to 2016’s twin political shocks – Brexit and Donald Trump’s election victory – as evidence that polls are fallible, but this argument is simplistic.
With both Brexit and Trump the difference between polling and outcome was “significantly narrower than the caricature”, notes Barclays; polls continually indicated that both races would be tight. In contrast, no poll has shown Le Pen coming within 10 percentage points of her second-round opponent, likely to be either Macron or under-fire centre-right challenger François Fillon.
While the polls underestimated the support for Brexit and Trump, the margin of error would “have to be multiplied several fold” for Le Pen to win, says Barclays.
Even if Le Pen does win it doesn’t automatically follow that France will leave the euro zone. She would need to secure a parliamentary majority to force a referendum on the issue, the odds of which appear slim. Secondly, she is unlikely to win any such referendum, with polls indicating that the French public would vote to retain the single currency.
While the possibility of Frexit remains remote, it is not impossible. Although the polls indicate Le Pen has little chance in a second round run-off, the bookies give her a real chance, many firms pricing her at around the 2/1 mark.
Things can change quickly in politics – not so long ago Fillon was hotly tipped to win but his odds have collapsed since becoming embroiled in a financial scandal.
Trump was 11 points behind Hillary Clinton late in the US presidential election race, but a late swing in political fortunes changed the race entirely.
Le Pen could benefit electorally should France suffer another terrorist atrocity in the run-up to the election given that anxieties about migrants and terrorism have fed support for her nationalist message.
Were she to win the presidency might she gain enough momentum to win a majority in June’s parliamentary elections? In a charged political environment, might French voters be persuaded to upset the political establishment in an anti-EU referendum?
The risks are slim but not negligible. Higher-risk premiums are “legitimate” until clarity emerges, Amundi Asset Management said last week.
Some might argue that a Le Pen victory would not be a tumultuous event; if Brexit and Trump were not able to engineer anything other than short-lived selloffs why should this time be any different?
However, Brexit and Frexit are not the same. Britain never signed up for the euro; leaving the monetary union could spark a capital flight from France and peripheral euro states like Italy, warns Commerzbank, causing widespread turmoil and endangering the EU itself.
France leaving the euro remains an outside bet even if Le Pen does win, as noted earlier, but the merest prospect of same means that an upsurge in market volatility should be assumed.
Danish outfit Saxo Bank likens the potential impact to that seen in the aftermath of the 1981 presidential election, when the Cac 40 fell by almost 20 per cent after François Mitterrand won on a hard-left platform that spooked investors.
Global asset management firm Columbia Threadneedle Investments warns that a Le Pen victory could slice up to 10 per cent off European stock markets, and up to 20-30 per cent off European banks.
For now investors will take comfort from polls that continue to indicate that the likelihood of a Le Pen victory remains small. If the race tightens, however, then a fresh bout of market turbulence is likely.