Well here we are, one day on following a setback for European populism, and as noted this morning, the “never Geert” rally pushed up both the single currency and regional stocks overnight in a truly impressive fit of optimism (although the equity rally has faded a bit since)…
In light of recent events – and considering OATs quickly gave back gains – we thought a bit of sobriety might be in order.
After all, the French elections haven’t happened yet and as such, “Le Pen risk” is hardly off the table.
We’ve spent a considerable amount of time in these pages discussing the extent to which € credit markets seem to be woefully mispriced ahead of 2017’s biggest (scheduled) political event. Indeed, the premium the market’s giving you on French IG versus non-French IG is pitifully thin and as far as French junk versus non-French high yield is concerned, there’s virtually no compensation for redenomination risk at all.
In a note dated Wednesday (4:42 EST, to be exact), Goldman lays out what to expect on the off chance Le Pen manages to emerge victorious. Below, find the bullet points.
In recent weeks, the 2017 French presidential election has been at the forefront of European political risks. Market participants have focused on rising support for populist Front National (FN) candidate Marine Le Pen and associated ‘re- denomination risk’.
Although our economists believe that Ms. Le Pen is unlikely to win the election, they estimate that she has the potential to outperform current opinion polls in the first round. We consider the potential impact on European equities of a Le Pen victory using the framework provided by our economists. We would expect:
- A steep rise in the equity risk premium (ERP) to levels last seen during the Euro area crisis (i.e., to 8%-9% vs. 7.5% currently), implying a downside move of 13% to 21% for European equities.
- A significant widening of sovereign spreads.
- A large sell-off in European risk assets. We would expect the clear relative winners to be the DAX, SMI and FTSE 100. The last two are defensive indices and, moreover, are not in the Euro area. The DAX would benefit as investors turn to German assets given increased re-denomination risk in the Euro area. We would expect Euro area Banks (SX7E), the FTSE MIB and CAC 40 to be worst hit, followed by the IBEX.
- We would expect Country selection to become more important than Sector selection, as was the case before the introduction of the single currency and during a brief episode of the Euro area sovereign debt crisis.
And speaking of “last seen during the sovereign debt crisis” and “mispriced” markets, don’t forget just how sanguine € credit truly is versus 2011/2012 despite the outsized representation of French credit risk at the index level…