French voters have done what the markets largely expected them to do. For months now, the single most likely outcome of the first round of presidential voting was seen as a run-off between the centrist independent Emmanuel Macron and the leader of the rightwing National Front, Marine Le Pen. That, after a close and dramatic election, is what has resulted. It makes a change from the surprises of the last 12 months.
Could it also be a change that this time markets react much as they were expected to in advance? So far, it looks that way. Even though this was largely expected, and even though the very market-unfriendly Ms Le Pen remains in the race, there has at the time of writing been a huge move upwards for the euro. That makes sense as Mr Macron fared well, and appears clearly the best-positioned candidate to beat Ms Le Pen.
What effect will this have on markets? For the immediate future, it is reasonable to hope that the euro will stay strong, and that this could help a budding rotation into European stocks.
Positioning justifies a strong rise for the euro. These are the net under- and over-weight figures from the latest Bank of America Merrill Lynch fund manager survey.
With investors historically short the euro, it is not surprising that the euro gained almost 1.5 per cent against the dollar as the results came out. It is also reasonable to expect French bonds to outperform as the elevated yield spreads over Bunds, to reflect political risk, begin to narrow. That in turn should boost banks, as this chart from Citi’s Jonathan Stubbs makes clear.
But what about the stock market? So far this year, European stocks have slightly outperformed US stocks, on a common currency basis. Investors are already amply positioned in European stocks. According to BofA, institutions are as overweight as they have been in more than a year, while retail investors are also growing enthused.
Given that many still, with some reason, consider European equities cheap compared with the US (see below) it is reasonable to expect European equities to enjoy a bump out of the French news.
But there are several caveats. First, and most importantly, data on economic growth and corporate earnings needs to stay robust. And second, in the short term, Mr Macron needs to do what is expected of him and defeat Ms Le Pen. If he fails to do this, all bets are off, and his personality and personal record are likely to come under intense focus over the next few weeks now that he appears to be the most likely next president.
In the longer term, the list of potential trouble points in Europe remains long. It is headed by Italy, where the anti-EU Five-Star movement has been consolidating its strength in the polls, and where an election is due early next year. Italy’s banking problems refuse to go away.
Beyond that, there are risks associated with Brexit, and with the intractable Greek debt situation, while Germany’s election could yet require everyone to a leader other than Angela Merkel for the first time in a decade.
And then there is the issue of France under a president Macron. He has no party, and can be seen as an anti-establishment candidate. That means that the status quo has just received even more of a savaging in France than it did in the US and the UK. He lacks any party support at all in Congress, and he has to deal with the conditions that have seen steady growth in support of anti-immigration parties, and for the hard left.
There is no question that a Macron presidency should work out better for international markets than the alternative. But the French vote shows deep and intractable dissent, with which he could find it difficult to deal.
Why worry? It is a good question. The world is still in one piece, globalisation has helped to raise many in the developing world out of poverty, and the economy in the developed world is picking up steam. In France, it looks as though the status quo is on course for a significant victory over the forces of populism.
The problem is that once you start listing geopolitical issues, and the potential long-term problems presented by demographics and the hangover of low interest rates left by the financial crisis of the last decade, the list of reasons to worry grows even longer than Monty Python’s famous laundry list. Terry Jones was famously worried about the baggage retrieval system at Heathrow.
This was a list produced before the French election results by Longview Economics in London:
Weak US housing starts, falling prices of US second-hand cars, sharp falls in the iron ore price, and a spike in volatility are among many current market concerns. Indeed there are suggestions from some quarters, that a fall in the iron ore price is a precursor to a fall in the S&P 500.
Note that none of these reasons even mention the US president. The litany of foreign policy reasons to be worried includes the situations in Syria and North Korea, and ongoing issues with the oil market.
And yet there is comfort with the notion that there is little need to worry. Even those who acknowledge risks, and believe markets to be overvalued, are still not worried.
This chart is from BofA’s latest fund manager survey. There has never been a great agreement that the US is the world’s most overvalued stock market.
But confidence remains that US stocks are moving higher anyway, even though they are too expensive now. The following charts come from Bespoke Investment Group, and are based on Yale University’s investor confidence indices. They show a belief that US stocks will be higher a year from now, coexisting with a belief that US equities are historically overvalued.
Yale’s valuation index shows the proportion of investors who think that stocks are fairly valued or too cheap, so lower levels mean more believe that stocks are overvalued.
There are ways that these ideas can (just about) be reconciled. Many might believe that stocks look expensive relative to their own history, for example, but cheap relative to bonds — but this would suggest that investors feel dependent on low bond yields.
Bespoke combines the measures by subtracting those confident on valuation from those confident on future appreciation, to create an “irrational exuberance” indicator. This is what that indicator looks like over time.
Since the immediate aftermath of dotcom bubble, then, irrational exuberance has never been greater. The “wall of worry” has been scaled. Bespoke’s interpretation is negative:
The key takeaway from our combined “irrational exuberance” indicator is that investors think simultaneously that the market is over-valued but likely to keep climbing: that’s the exact phenomenon famously described by former Fed chair Alan Greenspan in a December 1996 speech. Robert J. Shiller, the originator of the Yale Investor Confidence series, is rumoured to have first invented the term; he later wrote a book with the same title.
A perhaps better way to look at this is “irrational equanimity” — a total lack of worry. The underlying strategy still seems to be not to worry about a thing, because every little thing is going to be all right.
Join me and George Magnus at the FT in London on May 15 for evening drinks and a discussion on the coming China bubble. Tickets are on sale here.