European Stocks Resilient Despite French Political Turmoil

Top strategists from Wall Street have asserted that the recent political turmoil in France, which has led to a government reshuffle, has already been priced in by the market and is unlikely to derail the European stock market's upward trajectory, which has been the best relative to U.S. stocks in nearly two decades. Despite the unexpected decision by French Prime Minister to initiate a vote of confidence over a budget stalemate, causing investor sentiment to fluctuate, strategists from Goldman Sachs, Citigroup, and JPMorgan Asset Management have expressed confidence that the risk of this crisis spreading to other European countries is low. This optimism is underpinned by Germany's historic fiscal reforms and the overall robust economic growth prospects across Europe.

European luxury goods manufacturers and other industries with significant international exposure are expected to benefit from the easing of global trade tensions. Following an initial sell-off, key constituents of the French CAC 40 index, including LVMH, Hermes International, and L’Oreal, have recovered their losses from the week. A strategist from Citigroup noted that while it is easy to assume that another political crisis would lead to a sell-off in European assets, the market has already factored in bearish scenarios. The positive outlook for Europe remains centered around Germany's stable economic conditions, while French asset prices already include a premium for political risk.

Year-to-date, the Stoxx Europe 600 Index, when measured in dollars, has outperformed the S&P 500 by nearly 13 percentage points, marking the largest advantage since 2006. This performance is driven by Germany's substantial spending plans, a stronger euro, and a trend of capital outflow from U.S. assets in the first quarter. Although recent investor interest in U.S. tech stocks has prevented the benchmark index from breaking its March high, market sentiment towards the European economy has improved. A strategist from Goldman Sachs stated that the current French political crisis has not impacted economic growth, and from a broader European market perspective, there are no significant concerns. The market has long anticipated the fragility of France's political situation.

Following the announcement of the vote of confidence, the CAC 40 index experienced a maximum decline of 3.3% over two trading days, and the yield spread between French and German 10-year bonds reached its highest level since April. However, by Wednesday, some of these losses had been recovered: the Paris CAC 40 index rose by 0.4%, and the Stoxx Europe 600 index stabilized after two consecutive days of decline. Despite high U.S. interest rates, the improving long-term profitability outlook in Europe remains a key factor supporting market resilience. Data indicates that the growth rate of the eurozone's private sector reached its fastest pace in 15 months in August, and manufacturing ended a three-year slump.

An investment portfolio manager and strategist from BNP Paribas Asset Management noted that since mid-March, corporate earnings expectations have been consistently downgraded, paving the way for analysts to start upgrading their forecasts. They added that for market trends, positive economic data and improving prospects for the Chinese economy are more important than political uncertainty. The strategist suggested that the current situation in Europe might present a good entry point for the stock market. So far, the most significant impact of French political events has been on the bond market, with the yield spread between French and German 10-year bonds widening to 80 basis points since April. This spread has made French government bonds more attractive relative to U.S. bonds. A global investment strategist from PGIM Fixed Income stated that while risks have increased and market anxiety is evident, the current situation in France is not unprecedented. The chief investment officer for international fixed income at JPMorgan Asset Management indicated that if the yield spread widens to 85 basis points, it could present a potential buying opportunity, as Germany's more accommodative fiscal policy might prevent further widening of the spread.

In the foreign exchange market, traders also believe that the risk of domestic turmoil in France spreading to the entire eurozone is low. Data from the Depository Trust & Clearing Corporation showed strong demand for contracts betting on a euro rebound on Tuesday. The political turmoil this week is seen as a continuation of events in June 2024, when French President announced early parliamentary elections, resulting in a hung parliament. Since then, the CAC 40 index has fallen by 3.2%, while the Stoxx Europe 600 index has risen by nearly 6%. Over the past year, investors have erased the valuation premium of the French stock market relative to the German DAX index. Currently, the CAC 40 index's forward price-to-earnings ratio is 14.8 times, slightly lower than the DAX index, a rare occurrence in the past decade. Banks, highway operators, and energy companies are the most affected by the ongoing political instability, as a higher proportion of their revenue comes from the domestic French market. However, data from Citigroup shows that approximately 80% of the sales of CAC 40 index constituents come from overseas, meaning that industry giants such as LVMH, Sanofi, and TotalEnergies face lower earnings risks. A trading manager from La Financiere de l’Echiquier stated that the current situation in France is unlikely to change the overall upward trend of the European stock market and may even encourage some investors to buy on the dip.