We start on Sunday with French election risk (where else?).
I’m sorry to day that today, I don’t have any video clips of topless women protesting Marine Le Pen’s “fake feminism” (or, more generally, her populist bulls*t), but what I do have is a fresh look at how European equities are pricing election risk.
Note that a key theme we’ve explored in these pages and elsewhere is the extent to which the V2X term structure admits of a discernible “kink” to reflect risk around France’s electoral trial by fire. I’ve often compared that to the S&P 500 IV term structure to show that it admits of no such kink.
Going into February, the US was pricing this market as though there would be no knock-on effect from a Le Pen victory, whereas European equities were (and still are) at least making an effort to price in the risk inherent in a raving lunatic with designs on redenomination becoming President of France.
Well this morning, I bring you some great visuals and color via Bloomberg that I encourage you to consider when evaluating the extent to which European equities are accurately pricing risk.
As Bloomberg notes, “the spread between April and May Europe stock volatility futures has climbed on French election risks, and is starting to outstrip the rally seen in the equivalent contracts heading into the U.K.’s EU referendum.”
Here’s a look at said spread versus the OAT-bund spread (with the the latter in blue):
As Bloomberg goes on to note, “the vol spread has risen to about 5 from below 1 at start of February and that compares to pre-Brexit vote high of 8.”
But, “ahead of Brexit, the spread started to ease as polls consistently showed Remain would win, before spiking on the vote.” This time around, “modest changes in polls are having an amplified effect on pricing Le Pen risk in selective areas of the markets, as the National Front leader edges out from being a remote tail risk.”
In other words, the market is trying to learn from its mistakes. We were caught off guard by the Brexit vote and Trump’s victory, so now, we’re seeing relatively large moves as traders’ collective desire to avoid the pitfalls of underestimating the probability of a tail event is manifest in the amplification of tiny blips in poll numbers.
But, before you go getting too worried about a French redenomination event, consider the following commentary from the same reader who accurately predicted the game-changing alliance between FranÃ§ois Bayrou and Emmanuel Macron.
To wit, from a reader:
Stating the obvious, it is not necessarily correct to use interpretations regarding elections in one country and apply them in a different context and in a different country – this is cheap guesswork at best and ‘playing to the crowds’ at worstThe way media are building expectations about the potential disruption of a Le Pen election in France by drawing conclusions from the American election is a case in point
- it is exciting to forecast such a disruption and it guarantees good readership for the media (both low and high brow…)
- it plays to the natural bias of the public to over-interpret trends – yes, Mr Trump won in a complex process (which says a lot about his real expertise) but no, Mrs Le Pen hopes to win in a very different setting
- it is disturbing to see responsible commentators ‘run’ with the Le Pen story line of ‘I am the French Trump’…As much is at stake on the European plane in this election, it probably should be relevant for careful analysts to remember what the ‘National Front’ – the party of Mrs Le Pen – represents in the French political landscape
- the party founded by Mr Le Pen senior after the Algeria war (1958-1962), in deadly opposition to General de Gaulle (who negotiated the end of the war and independence of Algeria), has been a fringe extreme right fixture of French politics for decades
- from 1981 -1983, break through for Mr Le Pen was, quite indirectly, engineered by the socialist President FranÃ§ois Mitterand to weaken his moderate right opponents, making the National Front an attractive alternative for some of the more right leaning voters
- the actual role of Mr Mitterand has been discussed endlessly and does not really matter – the point is that the ‘traditional right’ has made every effort to hold on to the ‘floating’ voters attracted by ‘Front’ themes
- Mr Sarkozy won the presidency with this strategy and Mr Fillon is preparing to do the same
- to become a fixture in national (and local) politics, the financial crisis of the 2000’s , the negative impact of globalization on broad segments of the economy and, later on, massive immigration resulting from the Middle East wars and break up of Libya (opening the Mediteranean route for impoverished African countries) all contributed greatly
- these strains bear definite similarity with the electoral base in the US and in the UK
- the question is how many additional votes these more recent trends actually would represent in a run-off against any right (Mr Fillon) or center left (Mr Macron) candidateBased on past results, Mrs Le Pen cannot possibly gather enough votes to win for a number of reasons
- the extreme roots of the Front, justifying torture in Algeria, and managing to joke about the Nazi concentration camps (all by Mr Le Pen senior), are not forgotten and, except for a minority of left diehards, the vote for ‘anyone but Le Pen’ will be massive on the left
- the ‘moat’ of the Front appears to be very stable around 25% – 28% (based on recent regional elections) with strongholds in the South East and in the North
- the nationalistic discourse against the euro and against the European Union is not well received (while anti-immigration stance definitely is coming ‘main stream’) – and certainly not by the more traditional rightIn summary, it cannot be demonstrated how Mrs Le Pen could increase her votes from 25-25% to 50%+These votes just do not appear to be there, neither coming from the left, nor coming from the right…Ultimately, this election is about Mr Fillon and Mr Macron and what either portends for the future of France in the European Union (and how this will reflect in the French and German economies and stock markets)More profoundly, it is about the deep splits in French society revealed by the powerful showing of the Front and also of the two extreme left candidates – gathering 55% of the vote between them in the first round. Taken at face value, and considering the key importance of France in the European construction, this cannot be good news.
National Front presidential candidate Marine Le Pen will have her speeches translated into English to avoid messages being filtered through press: Journal du Dimanche