“Listen, strange women lyin’ in ponds distributin’ swords is no basis for a system of government. Supreme executive power derives from a mandate from the masses, not from some farcical aquatic ceremony.” – Monty Python and the Holy Grail – 1975
Market nerves have predictably been jangling a little more visibly as this weekend’s first round of the French presidential election has neared. A narrowing race containing two candidates promising to upset the global economic applecart, so as to make France great again of course, is not helping. Safe haven assets, both imagined and real, have profited, while profits have been taken on some of the more economically sensitive areas of the market.
For our part, we remain focused on the constitutional restraints that would stand between either Marine Le Pen or indeed Jean-Luc Mélenchon in the still unlikely event that either did make it all the way to the Élysée Palace. These restraints should allow us to continue to concentrate on the wider fundamental backdrop for the world’s capital markets (including Europe). Polls still suggest that a neutral to favourable outcome for capital markets is still far more likely than the more difficult scenarios described below.
All that accepted, Jean-Luc Mélenchon’s remarkable momentum in the polls has forced a reassessment of the probability of an unfavourable outcome (for markets) from this Sunday’s first round of the presidential elections. This probability is still low admittedly, but many are rightly pointing to the high proportion of as-yet undecided voters, whilst remembering the shock political outcomes of last year.
A Mélenchon / Le Pen run off is obviously the worst-case scenario. In such an outcome, markets would likely react strongly – the euro, European stocks, wider equities, and peripheral debt would all be hit very hard, while all the perceived safe havens would catch a strong bid. A decent first round showing for Marine Le Pen, or even a Jean-Luc Mélenchon vs. Francois Fillon run off, may well have a similar if slightly less pronounced effect on markets.
The June legislative elections to form the national assembly would then assume even greater importance. Our base case is that, if they make it that far, neither Mélenchon nor Le Pen would muster sufficient parliamentary clout to carry out much of their incendiary agendas. Le Pen currently has just two deputies in the National Assembly and two senators. As per a 2008 constitutional revision made to Article 11 of the chapter dealing with the powers of the president, a referendum could be organised on the initiative of at least a fifth of the members of parliament. The Front National (FN) does have strong support in the south and northeast, but the two-round election system tends to restrain extreme political parties/platforms by design; voters must choose among a smaller set of options in the second round, and the parties are free to form alliances to stave off competition. Indeed, FN did not take control of a single regional government in 2015 elections despite winning the largest share of the vote – with a significant lead – in half of the regions during the first round. All this suggests that Marine Le Pen will struggle to get close to the 185 parliamentary seats needed to force a referendum.
The French constitution is a hybrid of the presidential and parliamentary systems usually seen in Western democracies. On the one hand, the president is elected by popular vote – which makes them the nation’s true political leader. On the other, the prime minister, selected by the president, must be supported by a majority in parliament. When the electorate chooses a parliament in opposition to the president, you get ‘cohabitation’, which would significantly curtail presidential authority over domestic issues, limiting it to foreign affairs and defence.
With regards to the UK, there are plenty out there telling us what snap elections do and don’t mean for Brexit negotiations, meanwhile FX markets seem to have spoken pretty clearly – a snap election and the less fragile Tory majority that the polls currently tell us will ensue should provide the wiggle room necessary to forge a transition agreement, which in turn is essential for the UK to avoid ‘hard Brexit’. Maybe, though we would steer clear of strong predictions here, particularly as they may not be necessary anyway. In our opinion, the difference between hard and soft Brexit may not be as stark as advertised from the perspective of the world’s capital markets, where the UK economy remains a relatively minor player. Even sizeable changes in the UK’s trend growth rate may not be noticed by capital markets if the rest of the world economy, particularly that of the US, is doing fine.
With regards to the negotiations, we would reiterate that on the European side of the table, there has to be explicit downside to not being a member of their club; simple self preservation demands it. On the other hand, it is likely not in Europe’s best interests to decimate a major trading partner. It is this balance, not the size and tenor of the Conservative parliamentary majority that will likely be the dominant factor in the negotiations to come in our view.
Investors could surely be forgiven for hankering for a ‘farcical aquatic ceremony’ instead of the hair-raising twists and turns that the developed world electorate seems intent on inflicting on them. However, the accumulated defences against populism in the developed world, both constitutional and otherwise, are considerable, as the US is so far illustrating. We remain overweight Continental European equities in our current tactical allocation. This position is a key part of a tactical posture that we would describe as moderately pro risk, consistent with our belief that the world economy remains in good and improving health, but entering the last, potentially multi-year, phase of this elongated economic cycle.