Following on from client emails, asking about France and the impact of a change in government on the multi-asset portfolios.

At the last catch up we spent a lot of time trying to debate/discuss/explore the impact a Trump presidency might have. I mention it here mainly because I think Trump is a far more consequential event for the multi-asset funds (from a risk perspective) than I do Marine La Pen and the National Front (NF) coming to power in France.

Still, what might it mean? Well, France had been leading Europe with regard to Ukraine, and that would likely stop. It is quite possible Russia would win, and quickly, without French support. That is very bad, I think, for humanity and quite likely bad for Europe in the longer run, as it’s not clear that Russia will end its global ambitions with Ukraine.

But I don’t think it means the region immediately descends into war. Russia may need decades to rebuild from losses incurred to date. So how UKR-RUS plays out as a function of French elections is probably not material on a 10 year time horizon.

Le Pen would probably mean more tariffs, but that kind of protectionist anti-globalist rhetoric has already been going for a while, led as much by the US against China, as anything else (recall the trade and tarriffs war between Trump and Xi).

However, for the benefit of being balanced and paying attention to “dark corner outcomes,” there is a worry this could take on a “FREXIT” type event, where France decides to leave the Eurozone. That is very hard to believe. How could anyone look at the UK and go “gee, BREXIT worked really well, I’ll give it a go too!”. But still, that is a possibility. And so, do French debts and deficits suddenly make the region like an Asia 1997-type event? Even as I type it I was shaking my head, but I do accept that’s where some commentators are at.

French equity markets are not expensive (see below, top left, 13x foward PE)…

…and the CAC is already down 10%, so a lot is priced in? However, it is fair to say I don’t think the French economy would do as well, and that absolutely would hit corporate profits and thus earnings per share, which drive markets. Forward earnings per share estimates (see below, top left) have flatlined somewhat, although earnings growth has been considerably faster than the market (indicating PE contraction) over the last four years.

Budget deficits (populist governments like to spend) might widen, and we can see yields on French debt relative to German debt pricing that reality in already.

What makes it even riskier is that the budget deficit is already large, quite comparable to the US (US is ~6%, France is closer to 5%, as a percentage of GDP, but without the US exceptionalism and strong growth). France is also running a trade deficit, leading to the dreaded “twin deficits”, meaning that in general, they are living beyond their means, in an already inflationary environment.

Still, overall, I imagine the same thing there, would happen the same time anywhere a government is formed from a populist party that’s only ever been in opposition, and that’s fail. Give it a couple of years, and they get voted out. How bad would or could that be? If I think of all the fears we’ve had about Europe, the European project, it’s all turned out better than ever expected at the time.

Euro Sovereign debt crisis? Draghi to the rescue via “whatever it takes”. BREXIT leading to the Eurozone disintegrating? The deindustrialisation of Germany? Dependence on Russian gas leading to a crisis if when said gas was ever to be revoked? All of that turned out to be wrong. All of it, of course, hit markets and hit them hard at the time. When RUS-UKR war broke out Stoxx dropped by over 20%; we bought at the time, and it worked out well.

I guess what I am trying to say is that all of the well grounded fears about the fragility of Europe wound up being overcome, in the same way US equities climbed “the wall of worry”.

In summary, France is a very small aggregate exposure across our various multi-asset portfolios (the exact number will vary). Our European equities position is low single digit, and France in turn, is only a fraction of Europe. And of course, international equities is just a proportion of the balanced (between 25-30%).

All of these points about equities apply equally well to bonds, where France is an even smaller exposure to the multi-asset Balanced portfolio.

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