French presidential election: where do we stand?

Let us remind that the first round on April 23^rd decides of the two candidates who will compete on May 7, 2017 to become French President. Right now the polls are unusually tight with four candidates close to 20 %. The last Elabe survey gives Macron (center) at 24 %; Marine Le Pen (far right) at 21.5 % ; Fillon (right) at 20 % and Mélenchon (far left) at 19.5 %. All recent polls are showing similar results.

Given the tightness of the race and the still important number of undecided voters, six first-round outcomes are possible: four are expected to be rather benign for financial markets and leave the French economy on its present track; the other two could however turn out being disruptive.

The four benign outcomes for investors are:

• The three in which Macron is qualified for the second round, as all the polls are pointing towards his victory in  the second round (by a significant margin) whoever is running against him.
• A Fillon / Le Pen run-off is expected to lead to a Fillon victory in the second round (although by a smaller margin).

The two disruptive outcomes are those that have a good chance of leading to a Mélenchon victory in the second round. This would be the case according to the recent polls if there is a run-off between Mélenchon and Le Pen but also, more surprisingly, if the run-off is between Mélenchon and Fillon: right now polls show Fillon losing by far in the second round with close to 60 % for Mélenchon.

The campaign of Mélenchon has clearly gained a lot of momentum over the last month leading to a rise in first round voting intentions for him. Should he qualify for the second round against Le Pen or Fillon, markets could start to fear the negative consequences of his program for the economy. His program is clearly of the “far-left” type. It doesn’t only envision to initiate a process that would change the French constitution (moving from the V^th to the VI^th Republic), but, also to move to a 90% taxation of incomes above 400 000 euros, to increase by 16 % the minimum wage, to bring back retirement age to 60, to reduce weekly hours worked further with an objective of 32 hours, to introduce one more week of paid leave leading to six weeks for most wage and salary workers… If implemented his program would quickly lead to economic disruption.

This being said, the polls on a “Fillon vs Mélenchon” run-off have a short history and despite a wide margin, the momentum could turn between the two rounds with many mainstream politicians both on the left and right insisting on Mélenchon’s program dangerousness.

Moreover, legislative elections will follow in June and should Mélenchon win the presidential run-off, his ability to gain a majority and to implement his plan is far from granted. Right now, there are no polls available and hence no clear view on the future composition of the Lower house but it seems likely that Mélenchon will have to govern with a majority that would mitigate the implementation of his leftist platform. The risk in the meantime though, is to see capital flight, political upheaval and possibly social instability.

The first round of the French presidential election in shouting distance is just one of several (geo)political event risks leading to higher uncertainty:

• For the time being we continue to think that one of the four “benign” outcomes will occur on Sunday 23^rd, but we acknowledge a rise in the probability of having a more “disruptive” outcome. The least market friendly scenario, a run-off between Mélenchon and Le Pen, would likely lead to an immediate risk-off reaction via spread widening, equity sell off and a weaker euro. The second adverse scenario, Mélenchon facing Fillon in the run-off on May 7^th, would also trigger an immediate risk-off market reaction but could evolve during the two weeks between the two rounds. Today, the few available polls are in favor of Mélenchon. In a nutshell, we think that financial markets have not yet priced in the impact of the possible run-off scenarios which would destabilise France and call into question the cooperation between European countries. On the opposite, the most market friendly outcome for markets would be a run-off between Macron and Fillon as both candidates have a pro-business reform agenda without questioning the European project.
• The rise in geopolitical tensions on Syria and North Korea appear to be a new source of uncertainty as the military enforcement of a “Pax Americana” was not expected during the first 100 days of the Trump presidency.
• Regarding the US more specifically, the House failure to approve the healthcare reform and the subsequent slippage in the timing of the fiscal stimulus represent additional headwinds.

Overall, this has led us to reduce risk in our portfolios. We have adopted a more cautious stance (vs. previously overweight) in our asset allocation strategy and added further protection on the Eurozone and the US as a hedge against a potential additional rise in political uncertainties over the coming weeks.

We have therefore tactically cut our equity overweight on EMU after the strong outperformance during March. The significant valuation discount can only disappear if political uncertainties recede. Earlier on, we already took profit on our US equity overweight after detecting warning signs in the large gap between survey optimism and actual activity data.