French Services Sector PMI Divergence: Opportunity in Consumer Discretionary Amid Optimism Fade

The French Services Purchasing Managers' Index (PMI) for May 2025 edged lower to 49.3, marking the sixth consecutive month of contraction. Yet, beneath the headline figure lies a critical divergence: while demand and optimism have waned, employment trends and sector-specific resilience suggest a tactical value investing opportunity in consumer discretionary equities—specifically travel and leisure stocks like Accor and the iShares MSCI France Consumer Discretionary ETF (EWFD). History shows that PMI troughs often precede rebounds in cyclical sectors, and with the European Central Bank (ECB) poised to cut rates further, now is the time to act.

The Divergence: Weak Optimism, Resilient Hiring

The May Services PMI contraction of 49.3 reflects ongoing softness in domestic and export demand. New orders declined marginally, with export orders falling at the fastest rate in five months, as political instability and fiscal tightening dampen corporate spending. However, the employment sub-index reveals a counterintuitive trend: while services sector job cuts accelerated to their sharpest pace since October 2020, this reflects cost-cutting discipline rather than systemic collapse. Crucially, hiring in transport and logistics (e.g., road freight) improved, signaling a shift toward efficiency over expansion.

The composite business climate indicator for services plummeted to 95.2 in May, its lowest since April 2024, driven by fading optimism about future demand. Yet, this pessimism is overdone. Input cost inflation eased to a near-four-year low, allowing firms to stabilize prices and retain margins. Meanwhile, the ECB's pivot toward rate cuts—expected to drop the deposit rate to 2.5% by year-end—will alleviate financing pressures, particularly for travel and leisure companies with high debt burdens.

Historical Precedent: PMI Troughs = Buying Opportunities

Consumer discretionary stocks historically rebound swiftly after PMI troughs. For instance, during the 2020 pandemic recovery, French travel stocks like Accor outperformed the broader market by 23% within six months of hitting PMI lows. Similarly, in 2021, the EWFD ETF surged 18% in the year following the services PMI's bottoming at 47.4.

Today's setup mirrors these cycles:
1. Valuations are cheap: EWFD trades at 14x forward P/E, below its five-year average of 16x, despite improving cost dynamics.
2. ECB support is imminent: Rate cuts will reduce refinancing costs for leveraged firms and boost consumer confidence.
3. Sector-specific resilience: Road freight and tech-driven services (e.g., delivery platforms) are stabilizing, creating a floor for discretionary demand.

The Risk: Avoid Rate-Sensitive Sectors

Not all sectors are poised to recover. Rate-sensitive industries like banks (e.g., Société Générale) and utilities face headwinds as ECB rate cuts erode net interest margins and regulatory costs rise. Meanwhile, manufacturing—a sector with improving employment—remains disconnected from services' struggles, making it a less compelling play.

Immediate Action: Buy Consumer Discretionary Now

The May PMI contraction at 49.3 is likely the final trough before a cyclical rebound. With the ECB's dovish stance, easing input costs, and resilient hiring in logistics, travel stocks are primed to outperform. Investors should:
1. Overweight EWFD: Capture broad exposure to French consumer discretionary firms at a valuation discount.
2. Target Accor: Leverage its exposure to recovering leisure travel and urban regeneration projects.
3. Avoid rate-sensitive sectors: Banks and utilities will lag as the ECB's easing benefits borrowers over lenders.

Conclusion: The Inflection Point is Near

The French Services PMI divergence presents a classic value-investing opportunity: fear of weak demand is overpriced, while underlying resilience in hiring and cost dynamics is underappreciated. With the ECB's rate cuts and historical rebounds as catalysts, now is the time to deploy capital into undervalued travel and leisure stocks. Delaying action risks missing the recovery—act decisively before optimism returns.