France’s snap election: a threat to Europe’s financial stability?

It was all looking up for Europe. Economic statistics were improving, the stock market was reviving; there was even an interest rate cut to boost growth and confidence. However, the region’s pesky politics have once again interfered with this encouraging picture. Could the election in France destabilise the region’s nascent recovery?

The immediate signs have not been good. The French benchmark index, the CAC 40, has dropped almost 4% since Macron’s decision to call a snap election* in response to gains made by Marine Le Pen’s hard-right party, National Rally (RN), in the European parliament elections. It is, by almost all measures, a high-risk strategy. The RN is significantly ahead in the polls, and a win in elections for the Assemblée Nationale would make it extremely difficult for Macron to pursue his legislative agenda. The elections will be held on June 30th and July 7th.

Fund managers will usually say that politics is ‘noise’, and do not tend to influence the way companies are run. That said, the wobble can’t be dismissed entirely. France is a large and important economy – the second largest in the region**. It is also highly indebted, which leaves it with some fragility. Debt to GDP was 111% in 2023***. The fear is that a far-right government could pursue high-spending “France first” economic policies, adding to this debt burden.

France is also the largest weighting in the MSCI Europe ex UK index, comprising just under one quarter (23.4%)**** of its market capitalisation. While most of its largest companies do not depend on the French economy for growth, it could dent reviving confidence in the region’s markets. Small and mid-caps that are more domestically focused would also be more vulnerable.

Equally, the Eurozone tends to be seen as a bloc and French weakness may be felt elsewhere. There has already been some weakness elsewhere. Of the two other major markets in the region, the German Dax has dropped 2.52% since the election was called, while the Swiss index has dropped 0.24%.* This compares to a rise of 1.73% for the S&P 500*.

Low expectations

However, expectations are not high for European companies, with the region’s markets trading at a significant discount to their international peers. Niall Gallagher, manager of the GAM Star Continental European Equity fund, says: “In our asset class, there is a realisation that certain parts of it are very cheap. For example, we’ve seen a strong performance from European banks this year. The world has woken up to banks trading on the wrong valuations…Elsewhere, the fundamentals for European equities are pretty good. We have seen strong results and guidance statements.^” His view is that valuations still give a good margin for error, particularly compared with the US.

These valuations have caught the attention of corporate and private equity buyers, with merger and acquisition activity picking up across the region. This is particularly true for the small and mid-cap companies. While they may be more vulnerable to weakening confidence around the French election, it is also where the greatest value lies and where M&A activity is strongest.

David Walton, manager of the IFSL Marlborough European Special Situations fund, says: “We are not the only ones who believe the current valuations of some European smaller companies look appealing. We have seen a flurry of merger and acquisitions activity, with bids for five companies held in the fund last year and one more already this year. The opportunity is even more pronounced in the current environment because many well-managed smaller companies in out-of-favour sectors are on significantly lower share prices than they were two years ago.^^”

Economic recovery

There is also a greater sense of economic optimism across Europe. Niall says: “There is increasing evidence that things are getting better in Europe, certainly on the consumer side. A combination of falling energy prices, falling utility prices, falling food prices and rising wages should be good for consumption in Europe.” He believes as the market becomes more constructive on economic growth and further interest rate cuts, this should also favour the mid-cap space.

Marc Schartz, portfolio manager on the Janus Henderson European Focus fund, agrees: “More confidence around sustained economic growth and an end to monetary tightening would be beneficial to mid-caps. Everyone has a view on the macro, but we also know that most people get it wrong most of the time, so that’s not a call we want to make here. Getting the timing exactly right is a very tricky game and I think it misses the bigger picture. The bigger picture for me is that the setup for mid-caps is currently more attractive than ever.

“What has never changed is that mid-caps offer access to secular growth in less overhyped, less crowded conduits. So we talk about stocks that often fly under the radar of many investors. Companies that operate as an enabler for other companies which are more often associated with mega trends, such as electrification, data centres, or weight loss drugs.^^^”

Investor flows have also been improving, at least until the recent wobble. Europe ex UK was the fifth most popular sector for net retail sales in April, taking in £280m^^^^. After a long period in the doldrums, investors had been starting to re-engage.

There is a danger that a bad result in the French election could destabilise this, but the effect may be temporary. Populist parties historically have moved to the centre on economic issues when confronted with the realities of power. The latest example of that has been Giorgia Meloni as prime minister of Italy, who has proved more moderate in power than she was while campaigning. Equally, Emmanuel Macron will remain president until the 2027 presidential elections. This will act as a check on the ambitions of the RN.

With a handful of exceptions, political change in advanced economies tends not to be as bad as investors fear. Against that backdrop, any weakness may be an opportunity to pick up cheap European equities at even cheaper prices, particularly in the small and mid-cap sectors.

*Source: FE Analytics, total returns in sterling, 10 June 2024 to 17 June 2024

**Source: Forbes, 14 June 2024

***Source: Trading Economics, December 2023

****Source: MSCI index factsheet, 31 May 2024

^Source: GAM Investments, April 2024

^^Source: Marlborough Group, March 2024

^^^Source: Janus Henderson, 14 June 2024

^^^^Source: Investment Association, April 2024