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Authers Note: mightier than Le Pen

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?

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.

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