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Macron Wins, What is the Market Impact?

3 May 2017PoliticsEconomicsEurope
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Emmanuel Macron, an independent pro-European centrist will become the new president of France. In round two of the French Presidential election which was held on May 7th, Macron received 66% of the vote to far-right candidate Marine Le Pen's 34%. Macron's strong performance exceeds forecasts but still shows that the National Front has again grown significantly as a political force. Macron will take office by May 14.

Macron's win, as well as the victories of mainstream parties in the Dutch and potentially German elections reinforce Citi analysts' base case for relatively benign outcomes in European elections this year.

Market Implications

Investors have been warming up to European equities as expectations of a Macron win rose. In the week following round one of the election, European equity funds reported their largest inflows since late 2015. The euro also hit a six-month high leading into round two of the election on the weekend.

Equities: In addition to reduced fears that political instability will derail Europe's recovery, improving economic growth may also support European equities. The euro zone economy has started the second quarter on a strong footing with the final reading for the composite Purchasing Manager's Index (PMI) for April having revised up to 56.8, the highest in six years. Business optimism is high and employment in the services sector has increased for 13 consecutive months. A more stable political backdrop, an improving economy and attractive valuations could further increase the appeal of European equities. European equities are trading at a forward price to earnings ratio of 15.5x versus 18.5x for US equities. 75% of European companies had reported better than expected revenues for the quarter ending March. Citi analysts expect earnings for European companies (ex UK) to grow 19% this year.

Bonds: On the other hand, current low bond yields and prospects of tighter monetary policy in the eurozone next year have led Citi analysts to be more selective within European investment grade corporate and high yield bonds.

Euro: With the euro hitting a six-month high leading up to the election, Citi analysts believe that there could be limited upside post Macron's win.

Risks Remain

Investors should note that challenges remain for France and Europe. Given that the fragmentation of the political landscape implies that the 577 seats of the lower house will be shared by five main political movements, Macron may not obtain an outright majority in parliament, which can affect his ability to bring about reforms in France.

An anti-EU government could potentially come into power in Italy next year although Citi analysts believe that Italy's electoral system can help reduce the risks of extreme outcomes.

On balance, while investors with little holdings in European equities can consider dialing up their exposure, it is important to retain some perspective and keep their portfolios diversified.

Key takeaways

Macron's win, as well as the victories of mainstream parties in the Dutch and potentially German elections reinforce Citi analysts' base case for relatively benign outcomes in European elections this year.

A more stable political backdrop, an improving economy and attractive valuations could further increase the appeal of European equities. On the other hand, current low bond yields and prospects of tighter monetary policy in the eurozone next year have led Citi analysts to be more selective within European investment grade corporate and high yield bonds.

Investors should note that challenges remain for France and Europe. Macron is unlikely to obtain a majority in Parliament. Meanwhile, the Italian national elections early next year could result in an anti-establishment becoming the largest party in parliament.

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