Impact of the French legislative elections on the CAC 40 and second round polling
The recent first round of the French parliamentary elections wiped off all of the CAC 40’s near 10% January to May gains. The worst-case scenario of Marine Le Pen's far-right National Rally (NR) party securing an absolute majority in the National Assembly now appears avoidable, leading to a near 3% gain in the CAC 40 index over the past few days. However, the downside is continued political gridlock that prevents France from addressing its high budget deficit and halts President Emmanuel Macron’s pro-business reforms.
In the first round of the French legislative elections, held on June 30, out of 501 ministers of parliament (MPs), 76 MPs were elected including 39 for the National Rally (RN) and its allies, 32 for the left-wing New Popular Front (NFP) and 2 for President Emmanuel Macron’s Together coalition. This leaves 352 constituencies to vote by 8pm local time (7pm BST) on Sunday July 7, at which point nationwide projections will be published by pollsters based on a partial vote count. The poll results tend to be fairly reliable, but official results will gradually be announced throughout the evening and are likely to be tallied up by the end of the night.
Further turmoil for the CAC 40 ahead?
The political turmoil means the hangover for French markets could drag on for months. Since Macron called a snap election in June, the CAC 40 index has been the worst performing major European index. At the height of the selloff, France’s 10-year bond yield spread over Germany’s soared to levels not seen since the sovereign debt crisis.
The market is still very cautious and concerned about a hung parliament that could become a worry over the medium term and lead to a far-right French president being eventually elected in 2027 when Macron’s two consecutive terms in office are up.
While French election stress has eased somewhat, volatility remains elevated. A gauge tracking short-term volatility on the CAC 40 is still markedly higher than a similar measure for Germany’s DAX 40. One-month implied volatility on the CAC 40 has only recovered about half of the surge seen after the 9 June snap election announcement.
The CAC 40 also remains around 3% below pre-9 June levels. The premium investors demand to hold French bonds over German ones has fallen from highs above 80 basis points, but remains well above early June’s 50 basis points.
What is the option market saying?
Still, options markets suggest Sunday’s run-off vote should spark smaller stock moves than last weekend’s first round. JPMorgan Chase predicts a 1.9% one-day move in either direction for the CAC 40, compared to 2.9% previously.
What about the CAC 40’s valuation?
The past month has also removed the valuation premium awarded to French equities. The CAC 40’s relative valuation to Germany’s DAX is now near the lowest since before last year’s US banking crisis. Of note is also that at a forward price-to-earnings ratio of almost 14, the MSCI France index trades in line with its pan-European counterpart.
For investors willing to stomach short-term uncertainty, French stocks may present an opportunity, though. Companies with strong earnings outlooks look more attractive after the recent sell-off. Also, French firms generate over 60% of revenue abroad, limiting domestic political risk.
What about the French debt market?
On the fixed income side, bond investors seem poised to impose higher borrowing costs on France for years. This reflects not only political instability, but also the country’s 5.5% budget deficit and debt pile set to hit 112% of GDP by 2024, according to IMF projections.
Ongoing deficit and debt concerns mean the market is going to demand a higher risk premium on French debt until the fiscal situation is addressed, something which might be difficult to achieve while the left-wing alliance and centrist political parties form an uneasy coalition, the first in France’s five republics.
To buy or not to buy the CAC 40?
Some analysts argue investors should avoid overreacting to headlines and maintain exposure across French equities and bonds as underlying fundamentals of the French economy remain strong.
Ultimately, while risks are tilted to the downside, markets have already priced in much of the current uncertainty. Further major selloffs seem unlikely without additional negative catalysts beyond more political posturing.
For now, investors may need to strap in for weeks of volatility until the economic impacts of a new French government become more clear. But more panic selling out of French assets due to election uncertainty could preclude participation in any rebound once the political storm passes, as it usually tends to do.
Technical analysis on the CAC 40
The front month CAC 40 futures contract managed to stabilize above its mid-June low at 7,460 when it dipped to 7,468 last Friday before rising all the way to its 24 June high at 7,744 which is key for the medium-term trend.
CAC 40 daily candlestick chart
A rise and daily chart close above the 7,744 late June high early next week would confirm a double bottom chart formation and put the early to late May lows at 7,89-to-7,911 on the map, as well as the 55-day simple moving average (SMA) at 7,912 and the psychological 8,000 mark.
En route lies the May-to-July downtrend line at 7,796 which needs to be breached first.
Only a fall through the 7,460 June low would likely push the January low at 7,284 to the fore and perhaps even lead to the 7,000 region being revisited.
