While 2016 was the year of political shocks, 2017 may well prove to be reassuringly boring year in terms of political outcomes. Already, Dutch nationalist Geert Wilders failed to breakthrough and there is every reason to believe the French election result will be similarly benign. In which case, French equities should perform strongly over the rest of 2017.
But what if the worst happens and Marine Le Pen defies all expectations and we wake up on the 8th May to a France headed by a National Front President?
Expect the unexpected
The first thing to avoid is assuming markets will rally in the following months, as was the case following the seismic upsets of 2016.
The surprise vote in favour of Brexit had major consequences for UK investors. The UK gilt market performed strongly over adjoining months following the Brexit result, benefiting from both increased risk aversion and the impact of monetary easing by the Bank of England. Corporate bonds did sell off in the days following Brexit, but recovered strongly, propped up by BoE bond buying.
In the currency markets, the Brexit vote led immediately to a sharp and unsurprising decline in sterling against all the major currencies, which worsened through the course of the year. Meanwhile, the UK equity market, partly due to the effect sterling would have on the overseas earnings of UK companies, rallied strongly.
Over in the US, the election of Donald Trump in November shocked the world but the result also led to sharp gains in US equity markets, as investors priced in possible tax cuts and higher public expenditure. Meanwhile, the bond markets sold off as investors factored both a more growth friendly Keynesian-style fiscal stance and the impact of financing it.
A similarly broadly positive reaction by markets may not be the case following the election of Le Pen. She would be expected to follow far less investors friendly policies than Donald Trump. And in an uncertain world where Le Pen carries out policies endangering the stability of the EU and the Eurozone, we may well see the Euro depreciate sharply in value.
Bond markets at risk
Uncertainty over the status of Euro denominated debt, should the Eurozone begin to break-up in the wake of a Le Pen victory, could also impact the bond market. In this environment, investors may well decide that they are better off holding equities in European companies, which offer exposure to real assets and would benefit from the depreciation of the currency rather than French euro-denominated bonds. Fortunately, the risk of Le Pen becoming President seems remote at the present time.
The French electorate, in line with mood in much of developed world, seem increasingly willing to abandon the more traditional parties and candidates for novel or populist politicians. However, the nature of the French electoral system still makes it unlikely that Le Pen will triumph.
Macron in poll position
For most of the last year, Le Pen has led in polls for the first round of the French elections, as support for the candidates from more traditional parties has splintered. The current hugely unpopular socialist Prime Minister, Francois Hollande felt compelled to withdraw from the race and his party’s current candidate, Benoit Hamon seems highly unlikely to make through to the second round. Meanwhile, Francois Fillon, the candidate who had appeared favourite to win the Presidency, has, instead, become embroiled in numerous financial scandals.
This has left the unconventional Emmanuel Macron in poll position to win the Presidency. Though Macron served in in previous socialist governments, he has since started his own movement ‘En Marche’ and is standing under their banner.
While Le Pen is expected to win through to the second round whether she faces Fillon or Macron, the polling suggests that she will fall well short of sufficient support to win the presidency as left-wing and more moderate voters are expected to unite behind whoever opposes her.
This may well represent an investment opportunity: the markets have already priced a certain amount of political risk into the French equity markets, which appear cheap relative to the rest of Europe.
Chris Hiorns is fund manager of the EdenTree Amity European fund