With French election risk front and center, and having spent what is probably an inordinate amount of time talking about Marine Le Pen over the weekend, I figured it was just as well to go even more overboard by penning yet another post about the impending populist putsch (anyone see the irony in using “putsch” to describe French elections?).
One of the important things to consider when you think about the electoral trial by fire that Europe faces in 2017, is that we can’t really ring fence the effect on markets. There’s a lot of entanglement here.
Dutch elections are also being closely watched to see how much support there is for populist candidates. The populist poster child in the Netherlands is Geert Wilders (a complete f*cking lunatic – look him up). Consider that, and then consider the following chart from BofAML:
See the problem there? You’ve got an enormous amount of counterparty risk embedded in the Dutch banking system by virtue of its outsized exposure to France. But the Netherlands is itself dealing with a populist uprising. That’s what I mean by “entanglement.”
Along those lines, you might find the following color and accompanying visuals from Goldman interesting with regard to analyzing how a Le Pen victory would affect investors outside of France (note: it’s not all bearish, there are some comforting passages).
Over the past two weeks, the 10-year OAT-Bund spread has widened c.10bp, on the back of heightened concerns regarding the French presidential election. In the meantime, implied volatility (June expiry) has now become more expensive on the CAC 40 than the EUROSTOXX 50, a first in the derivatives market. Although the CAC 40 has recently underperformed other European indices we do not think this particularly reflects concerns about the election. The performance of the CAC remains strongly correlated with that of the SX5E, its most similar counterpart and we believe most of the recent underperformance reflects developments in Banks (SX7P) as well as Oil & Gas (SXEP), among the largest sectors of the French index (respectively 11% and 12% on a market cap basis).
It is worth noting that, while foreign investors own 60% of the negotiable French government debt, they own less than 40% of the French equity market. This is significantly less than the share of the UK or German equity markets held by non-domestic investors, at around 55%.
Current opinion polls indicate Ms. Le Pen, the Front National (FN) candidate, will qualify for the second round of the presidential election and that she would face either Mr. Macron or Mr. Fillon (26% for Le Pen, 21% for Macron, 17.5% for Fillon based on the latest Ifop poll). However, investors we have spoken to express increasing concern about a possible alliance between the leftist candidates Messrs Melenchon and Hamon. Such an alliance could help them qualify for the second round and, if so, with room for only two candidates in that round, such a situation could increase the chance of a victory for Ms. Le Pen, in particular in the event of a lower participation rate, which has historically shown to favour FN candidates. However, as argued by our economists, a victory for Ms. Le Pen in the final round appears unlikely in all possible combinations.