Remember what we said last night about having to think twelve steps ahead and how that mentality combined with headline hockey ca. Greece 2015 makes this entire enterprise (that is, the effort to say anything definitively “right” about markets) impossible? As a reminder:
Take OATs. Here’s a chart:
So what’s going on there? Well, first there’s the Fed. How should a “dovish” hike effect core EGBs? But wait, it doesn’t matter. Because OATs don’t trade like core EGBs anymore. Why? Because a lunatic has a non-negligible chance of becoming president and if she does, there’s a non-negligible chance she’ll drag France out of the EMU, triggering a €1.7 trillion sovereign default and leaving the entire € credit market to wonder what happens when something like €410 billion in French IG debt (roughly a quarter of the entire € IG market) is suddenly subject to a redenomination event.
Ok, so that’s the narrative, let’s analyze it that way. Fine. Geert Wilders fell short in the Dutch elections. Which ostensibly bodes poorly for Le Pen in France. So OATs rally. Makes sense. But then OATs suddenly gave it all back (see chart). Why? Well because again, everyone has to think twelve steps ahead and after all, the French elections haven’t happened yet. And then there’s Draghi. Is he going to hike ahead of a taper? Is there room to deviate from the capital key to prop up French debt if everything goes to sh*t?
Well, you’re seeing this in action again on Friday. Take a guess when this headline hit: “Le Pen, Fillon 1st-Round Support Up; Macron Stable: Opinionway”…
Here’s a subtle hint:
Now clearly it’s not the one point jump for Le Pen driving the action there. Rather, it’s the one point jump for Fillon that matters because his chances of beating Le Pen in the runoff are only 55-45 versus 59-41 for Macron.
But whatever. The point is, this is just like Greece in the summer of 2015. Every headline, no matter how inconsequential, moves markets and every “phew, looks like we’ve got some clarity” moment (in this case Wilders’ loss in the Netherlands) is promptly forgotten by the next day or, in the case of OATs on Wednesday/Thursday, within a few hours.
Yesterday we brought you “Here’s What To Expect If Things Go ‘Wrong’ In France.” Given today’s Opinionway poll (and we say “today’s” as if they don’t do one every single day), it’s probably worth your time to revisit that post, and to consider a bit of additional color from Goldman with regard to where you can hide in the event French voters turn out to be just as stupid as the American electorate.
Using the Euro area Sovereign crisis as a guide to the relative performance within equities. Although previous periods of Euro area stress do not represent a perfect gauge to assess what could occur if Le Pen were to be elected, such events can help us to estimate relative performance.
The correlation chart below shows that the FTSE MIB, the IBEX and the SX5E are the European indices that are most negatively impacted by a widening of sovereign spreads. By contrast, the FTSE 100 and the SMI tend to outperform the market. Within sectors, Banks, Insurance, Construction & Materials and companies with high financial leverage tend to be hit when systemic risks surface in the Euro area, while Low volatility stocks, Food & Beverage and Healthcare tend to outperform. Utilities, which is a defensive sector, nonetheless tends to underperform when sovereign spreads widen, given its domestic nature and sensitivity to political uncertainty.
We think the SMI and the FTSE 100 would outperform if Ms. Le Pen were elected, despite the appreciation of the Pound and the Swiss Franc versus the Euro. These very international indices realise 90% and 75% of their revenues outside their domestic borders, respectively, and tend to underperform when their domestic currency appreciates (e.g., in one week the SMI fell 16% vs. the SXXP when the SNB removed the peg of the Swiss Franc against the Euro, leading to a sharp 19% appreciation of the CHF/EUR cross). However, in very risk-off periods the equity/FX correlation of these indices can turn positive, as was the case for the FTSE 100 during the Euro area crisis.