European risk assets are likely to benefit in the short term from the election of Emmanuel Macron as French president, but political risk still presents a headwind over the longer term, according to asset managers.
Centrist Macron successfully defeated his adversary Marine Le Pen in the run-off vote on Sunday to become the new president of France. Macron received 66.1% of the vote to Le Pen’s 33.9%.
Macron, a former economy minister to outgoing president Francois Hollande, has promised to stay in the eurozone, reform the economy and create new jobs, but his effectiveness as president will depend heavily on the outcome of the parliamentary election in June.
Muted reaction
Market reaction to the vote was positive but muted as the result had been largely priced-in by markets following the first round of voting on 23 April.
The euro flourished early on, rising 1.5 cents against the US dollar on the news, but the currency remained more or less unchanged this morning.
Elsewhere, the excess spread of French government bond yields over equivalent German government debt reduced back to the 20 to 40 basis points (bps) range, down from 80bps where they stood prior to the first round of voting.
France’s Cac 40 share index dropped 0.9% after Macron’s victory, having earlier hit its highest level in more than nine years.
European equities expected to benefit
Many believe the result will lead to further inflows into European risk assets in the short term.
SYZ Asset Management chief economist Adrien Pichoud said European equity markets should benefit from the dispelling of the political risk premium over the coming months, but not in all sectors.
“Financial stocks and those oriented towards the European domestic market will be the main beneficiaries of the current economic dynamism and their valuations should begin to recover,” he said. “On the other hand, enterprises with significant exposure outside the eurozone might be penalised by the strengthening of the single currency.”
According to Allianz Global Investors global strategist Neil Dwane, there is a good chance political risk will be priced out further which should benefit European shares.
“Based on our analysis, European equities – which have shown higher revenues and stronger order books and should continue to outperform global equities – will have further upside potential as political uncertainty declines,” he said.
Elsewhere, the Blackrock Investment Institute issued a note saying it too is positive on European shares and sees potential for renewed investor inflows as focus returns to the region’s improving growth.
“European purchasing managers’ indexes point to the strongest economic activity in six years,” it added. “Europe stands to benefit from global reflation, and we see attractive valuations in cyclical shares.”
Fixed income presents challenges
While equities look full of promise, Legal and General Investment Management’s (LGIM) asset allocation team believes the most pressing challenges in the months ahead could be in European fixed income markets.
LGIM European economist Hetal Mehta and strategist Chris Jeffery wrote in an update: “On our estimates, the European Central Bank is on its way to owning nearly a quarter of the sovereign and non-financial corporate bond markets.
“The prospect of slowing down the pace of those purchases, i.e. tapering, has the greatest potential to disrupt the markets in the second half of the year.”
Similarly, Pioneer Investments head of global asset allocation research Monica Defend believes while political risks have eased, tapering talks in Europe could start to materialise and interest rates on government bonds in Europe could rise from the currently very low levels.
“We see some continuation of peripheral spreads tightening, as well as the French [government bond] spread over German bund,” she added.
“Elsewhere in fixed income, we are more cautious on the European credit market than at the start of the year as valuations have become tight and there is less carry to protect investors from increased interest rates. We prefer EU and Japan linkers and we expect inflation curves to steepen.”
Now the hard work begins
Manulife Asset Management head of European equities David Hussey said Macron’s victory is likely to encourage investors to move into Europe over the short term, especially on the back of better valuations, positive earnings growth and economic momentum.
However, he said from a longer-term perspective, all eyes will be on the new president’s efforts to reform the economy and create new jobs against a backdrop of anti-globalisation in the wake of a weaker global economy. Hussey added it is “more than likely” that the populist parties will return.
“In my view, political risk will remain around the western democracies until the wages and jobs situation improve,” he said. “And this will translate into persistent uncertainty and volatility for the markets.”
Royal London Asset Management head of multi-asset Trevor Greetham said Macron’s first challenge is to attract political backing, to form a government that allows him to implement the reforms France needs, in order to bring down unemployment and solidify support for the European project.
“However,” he added, “June’s parliamentary elections don’t carry the same near term risks for financial markets as the presidential election.”
