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June 24, 2024 - France: Tough choices ahead for voters (and investors).


France is home for some of Europe's gems whether in luxury, industrials, energy or consumer/household goods. And the likes of L'Oreal, Kering, Hermés, TotalEnergies, Schneider Electric to name but a few have all corrected due to the political situation. From a fundamental point of view such companies are truly international and derive only a small part of their revenues in France, making them rather insulated from local developments. But when investors decide to sell anything French, they too can suffer in the short-term. Facing, as investors, the dilemma of what to do with the French exposure, the decision is to keep (or even add to) the companies that can weather relatively well the current turmoil. But also we would have to reduce/sell the most obviously impacted by any bad turn in French politics: namely banks, utilities, construction/concessions and any company with state ownership. These are tough decisions to make, but the most rational thing to do.


The risk of France falling into a political chaos is not negligible. Of course, we always hope for the best possible outcome and to this point we should note that a significant part of voters change their minds at the last minute into a more rational choice, when stakes are high. The final result of the French general elections could be different than the recent Euro-elections outcome, as even Macron's party seems to be gaining some voters, in recent polls. But, we also believe that the country is getting into a volatile period ahead, as there is a lot of movement going on: the extreme left is creating its own coalition to advance into the second round and the extreme right is superficially (?) repositioning itself towards the center-right to win votes.


Below we present some scenarios and their probable implications:


a) A party achieves majority : namely, either Le Pen's party, Rassemblement National (RN) with Jordan Bardella as Prime Minister or the left-wing alliance Nouveau Front Populaire (NFP). Both outcomes would result in the so-called cohabitation, with the President and the Prime Minister belonging to different parties. Such a government would have full legislative powers to pass laws, and hence would imply the highest probability for a policy change. The president does not have a formal veto in the legislative process but would be able to delay the process (e.g. by referring bills to the Constitutional Council or by asking parliament to re-open the debate on a bill ). This scenario looks to be the most feared by capital markets, especially if the extreme left is in power, as the government will potentially be able to pass measures that will increase deficits and the debt, . But if Le Pen wins and repositions herself into a "Meloni", then the markets could probably rally in relief, in the short-term.


b) Both parties (RN or NFP) fail to obtain a majority. This is the most probable scenario. In this case, if Le Pen is the winner she will not appoint Mr. Bardella as Prime Minister, as she has publicly claimed. She does not wish to "burn" her party in a minority government that will be constrained to pass laws, as she is targeting the 2027 presidency. This situation could require a technocratic prime minister, and would likely entail the least policy change. Markets will initially like this scenario as the status quo will be maintained for a while, but uncertainty will be high. If the NFP is the winning party, things will get more complicated and markets will correct significantly in the short-term. But the left coalition is also very fragile and it is highly unlikely to last as a minority government.


The Swiss National Bank (SNB) cut rates again, to 1.25% and will be intervening in the foreign exchange, if needed. While the SNB noted that inflation had risen slightly since its March meeting, it presented a more dovish inflation outlook by stressing that the "underlying inflationary pressure has decreased again compared to the previous quarter". It also made comments about the "very important role" of the level of the Swiss Franc and their willingmess to use "monetary policy measures", (i.e. interest rates and FX interventions), to ensure that inflation remains within the range consistent with price stability on a sustainable basis over the medium term". And Chairman Jordan in the press conference showed that the SNB is concerned by the recent CHF strength, stressing that they are ready to act on both directions, i.e. sell the CHF if it strengthens too much (EURCHF below 0.900 perhaps is our own view) and buy it if it weakens too much (EURCHF above 1.0500 perhaps). All in all, we would probably do the same.


The Bank of England, on the contrary, kept rates at 5.25%, as widely expected. The minutes noted that 7 members voted for no change, while 2 members voted again in favor of a rate cut, just like last time. But this time, within these 7 votes, the decision at the meeting was "finely balanced", in a sign that the next move should finally be a rate cut. The minutes of the committee also showed an emphasis on the August meeting, with new macro projections and more information on inflation until then. All in all, the BoE did not surprise the markets, ahead of their own general elections.


US macro data continued to be on the soft side last week. The June Retail Sales rose by just 0.1%, vs expectations for +0.3% and the previous month was revised downwards. Taking the whole first half of the year all into account, we can see that retail sales have not grown at all since December. The weekly jobless claims remained close to 240k, which is the highest since last summer. The May housing starts were 1.28mn vs consensus for 1.39mn, falling 5.5% on a monthly basis vs expectations for a 1.1% rise. Single-family housing starts were 949k, 2.9% below April's figure of 977k. The Philadelphia FED Index dropped to 1.3 from 4.8 in the previous month and vs expectations for a rise to 4.8. All these data will probably sound "Chinese" or "Greek" to our readers, but the bottom-line is that the US economic data continue to surprise negatively in the last three months. This has implications both for interest rates, but also for equity valuations of the economic-sensitive sectors (Industrials, Financials, Consumer Discretionary etc.).


Eurozone June PMIs fell more than expected. The drop was equally pronounced in Manufacturing and Services as well as both in the region's biggest economies (Germany and France). The Eurozone Composite PMI fell to just above 50 (at 50.8) from 52.2 in May and vs expectations for a rise (!) to 52.5. Eurozone's manufacturing moved deeper in contraction territory (below 50) at 45.6 from 47.3 in May. Services fell to 52.6 from 53.2 and compared to expectations for a rise to to 53.5. The data are consistent with the latest negative macroeconomic surprises and make the case for further rate cuts by the ECB.


European equities managed to rebound, as Technology undeperformed in the US. After the initial shock of the previous week, when the French index lost almost 7%, investors came back and bought beaten down stocks. France rebounded by 1.7% and the Euro Stoxx 50 rose by 1.5% for the week. Of course the road ahead could be bumpy depending on the first round results this coming Sunday. Nasdaq finished almost unchanged, as there was a big reversal towards the end of the week in names like Nvidia, Apple and Microsoft as well as the broad semiconductor index, with profit-taking kicking in. The so-called Value stocks (Financials, Energy, Materials) fared much better, with Dow Jones rising by more than 1.5%, having underperformed in the previous period.


Bonds moved higher, especially in the Eurozone. The soft PMIs and the on-going political crisis in France have kept bond investors alert and turned them into buyers of primarily German bonds and high quality corporates. The German 10-year yield fell to a low of 2.35%, which is the lowest level since April and the US equivalent touched 4.20%, the lowest level since March. There was some minor profit taking towards the end of the week with yields slightly higher, by about 3-4bp from those lows.


Chart of the Week : France's fiscal situation cannot withstand financial experiments.


The current political turmoil in France could not have come at a worse timing, with respect to the country's public finances. The above chart shows the budget deficit for the last 20 years. It is worth noting first, that the country has not been able to run a surplus all these years, or in other words it is spending more than it is earning. But this is the case for many other countries in the Eurozone and the markets have been comfortable with for decades. We can also note that the 3% deficit rule imposed by the EU has been obeyed only in three of the last twenty. But most importantly, the current deficit of more than 5.5% is clearly unsustainable and has to be brought down by any government which is going to rule next. This necessary fiscal tightening (or reduction of spending in other words) is something neither competing party (Le Pen, Mélenchon) wants to hear about, as their priority is to spend even more. As mentioned in the previous weekly, markets will eventually push politicians into more reasonable spending however, but things usually have to get worse before they get better.


Disclaimer

• The content of this document has been produced from publicly available information as well as from internal research and rigorous efforts have been made to verify the accuracy and reasonableness of the hypotheses used. Although unlikely, omissions or errors might however happen.

• The data included in this document are based on past performances and do not constitute an indicator or a guarantee of future performances. Performances are not constant over time and can be positive or negative.

• This document is intended for informational purposes only and should not be construed as an offer or solicitation for the purchase or sale of any financial instrument and it should not be considered as investment advice. The market valuations, views, and calculations contained herein are estimates only and are subject to change without notice. Any investment decision needs to be discussed with your advisor and cannot be based only on this document.

• This document is strictly confidential and should not be distributed further without the explicit consent of Kendra Securities House SA.

• Sources: Chart of the Week : UBS , photo: Axios . com

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