The firming of independent Emmanuel Macron as heavy favourite to sweep the French presidential race marks what could be a significant turning point for European equities, which have been undermined by the threat of a break-up of the monetary union.
Heading for a second straight session of gains in Paris on Tuesday and poised to set a new post-financial crisis closing high overnight, the performance of the French bourse was notable for another reason: both the currency – the euro – and equities rallied in unison.
Stuart McAuliffe, chief investment officer of the listed macro fund manager Henry Morgan, predicted a Macron victory in an investor letter more than a month ago, and foreshadowed it would be the start of a 20 per cent “up year” in European stocks.
The blue-chip Euro Stoxx 50 Index is up 8.7 per cent year to date and 14.8 per cent over the past 12 months, and France’s CAC 40 Index is up 8.4 per cent this year after the 4 per cent rally on Monday, for an increase of 15.9 per cent over 12 months to 5268.85 points.
The S&P 500 is up 6 per cent year to date and 13.7 per cent over 12 months, but is still trading below its 2017 high of 2400.98 points on March 1, last closing at 2374.15 points. Rally expected
“Our take on European equities over the last six to nine months is they have been cheap on a relative basis, especially compared to US equities, but subject to one condition and that condition is that Italy, France or Germany do not leave the monetary union,” said Andrew Macken from Montgomery Investment Management. Now “the biggest near-term risk around a major nation leaving has dramatically subsided, I would expect a pretty strong rally in European equities for months to come”.
The fund manager had stayed out of financials in Europe because they are the most vulnerable to a break-up of the union, which would set in motion a sovereign default and significantly wipe out bondholders, including the financial institutions. “The downside risk is so enormous,” he said.
Montgomery swiftly increased its exposure to European equities on Monday.
“If Italy were to call an election, this risk would be back on the table. For the foreseeable future, I can’t see a world where this is completely off the table,” Mr Macken concluded.
With event risk out of the frame for the time being, investors believe valuations are much more favourable in Europe than the US.
“It’s a much more fundamental story [in Europe], whereas the US is really pinning their hopes on public policy which may or may not come. You’re really betting that Trump will ultimately be successful, whereas the bet in Europe is that you’re having a fundamental turn in the economy,” Mr McAuliffe said.
President Donald Trump will on Wednesday make public the broad outlines of his tax reform, targeting a lowering of the corporate rate to 15 per cent, as promised on the campaign trail. It is unclear how much of this is baked into US equity prices, which are trading at the upper end of their historical valuation ranges.
Mr McAuliffe thinks Europe has all the ingredients of a “multi-year” bull market, being cheap multiples, accommodative monetary policy, a cheap currency and shift in economic conditions as growth is upgraded.
“What’s interesting here is we’ve actually seen a lot of the radicals and nationalist parties not do as well as people suspected,” he said. With respect to depressed valuations: “A lot of it was bad debt in Europe, deflation, and a lot of those risks are coming off the table.”