I never knew the charm of spring
Never met it face to face
I never new my heart could sing
Never missed a warm embrace
(Yip Harburg, Lyricist, April in Paris, 1932)
April in Paris is a time of transition. The city is shrugging off the cool damp of winter. The cafes are seating more people outside than in. La Rive Gauche is coming to life at all hours. The weather can be spectacular, sunny and mid-60’s. But much like French politics, all of that can quickly unwind and send people scrambling indoors and out of the relentless rain.
We have, for some time now, maintained a skeptical view of Europe’s near-term prospects, but more bullish for the long term. A Winter and early Spring of structural, fiscal, political, and economic headwinds have kept us indoors or at least under cover. During that time, European equity markets have actually shown some strength after absorbing the blow from the UK “Brexit” vote. The FTSE All-Europe Index, measured in USD, returned 4.66% from before the last peak before the vote until the most recent close (April 18th). During that same period, the S&P 500 returned 12.78%. Advantage — US. Starting the clock instead after the market shock from the vote results (June 27th), those same indices returned 21.0% and 19.1% respectively. Europe drew down hard in the wake of the vote and rallied dramatically to outpace the US from then until now. During all of that, monetary policy from the ECB continued to be incredibly accommodative, maintaining in many cases negative rates across the zone. The earnings picture across Europe also brightened. Why are we still sipping espresso and carefully watching the green shoots of Spring climb out of the soil then?
In two words, immeasurable uncertainty. We do not invest solely on political signals, but we do acknowledge them as bellwethers of the currents driving markets. A wave of anti-trade, anti-immigrant, anti-integration sentiment has washed over the European region. The passions for isolationism have been stoked by terrorist acts, high unemployment, and a massive influx of immigrants in distress from the conflict zones in Syria, Iraq, Afghanistan and Northern Africa. We have to also allow for the likelihood that Russia has indeed been an invisible hand, since a disaggregated and isolationist West is a far weaker foe than the democratic hegemony that has encroached on their Western and Southern frontiers since 1989.
Geert Wilders, the anti-Islam anti-EU candidate for Dutch PM, was brushed back in the recent elections in the Netherlands but his PVV party still collected 20 seats. UKIP party leader Nigel Farage led what surprised many to be the successful vote to withdraw the United Kingdom from the European Union. The US followed close behind with its own lurch toward protectionism and isolationism in the November elections, sending a reinforcing message to Europe and the world. In the last couple weeks Recep Tayyip Erdogan consolidated considerable additional power in a hotly contested Turkish referendum, the campaign for which spilled across Europe, to modify the constitution to roll back the power of parliament, abolish the post of Prime Minister, and vest the Executive with more sweeping independent powers.
And yesterday, UK PM Theresa May caught everyone flatfooted by calling for a snap election in less than two months’ time even though she and her party were more or less secure until 2020. To read Ms. May’s statement this seems motivated by the same factors which drove US Senate Republicans to implement the “nuclear option” to clear Associate Justice Gorsuch for confirmation, which is to say, in the case of UK parliament to reduce the ability of the minority party (Labour), the Scottish national party, and “the unelected members of the House of Lords” to block the machinery of Brexit.
So, why our focus on French elections? If the trend continues, in fairly short succession the three oldest and most iconic Western democracies will have turned in on themselves. The US has the capacity to be self-sufficient in a closed system, although likely with stunted growth prospects. The UK needs to re-engineer all of its financial and trade alliances to have a chance and now the Scots are massing in the Highlands for another contest over their own exit (Screxit?) from the UK. If France takes a strong turn toward isolationism we are concerned it presents a more powerful hazard to the Zone and the Euro than the issues with the PIGS (Portugal, Italy, Greece, Spain) in seasons past.
Germany has powerful historical reasons for being the unwavering champion of the EU, and clearly benefits economically and societally from being the largest manufacturer in a 300+ million person trade zone. But, France is a critical partner to them in European leadership. If France disengages, those green shoots could be mowed down before they have a chance to blossom. The Schengen Agreement is already under threat, and the permanent closure of borders across the Schengen Zone, which would be an almost inevitable outcome of France closing doors, would reduce mobility of labor, restrict commerce, and limit tourism, just to name a few risks to the markets. All of the concerns about a collapse of the currency, that were visceral but distant with thoughts of Greece leaving (that would be Grexit), become much more tangible if France departs.
France is starting with a very crowded field of contenders, 11 at last count, four and possibly five of which are viable, and a few others of which can at best be called colorful and at worst illustrate some of the darker themes of the political season. The incumbent President, Francois Hollande, chose not to run for another term, which based on an approval rating in the single digits is proving to have been a wise choice. No one figure has emerged as a clear leader in opinion polls, and each of the competitive candidates is followed by a range of scandalous issues from nepotism and handing out no-show jobs to misappropriation of public funds.
The future is not clear for France with many of these contenders. Jean-Luc Melenchon, who is rallying in recent weeks, is a socialist liberal who would champion a French exit (Frexit?) from nearly everything outside its own borders and amplify many of the policies believed to have held France’s economy back like short work weeks, high progressive taxation on the wealthy, and earlier retirement ages. Marine Le Pen of the National Front is considered far right but still populist and isolationist, and is even more vehemently anti-immigrant, anti-trade and anti-EU. Francois Fillon, the Republican, plays as a conservative pragmatist with a track record that would put him at home in the US’ Republican party – rough on labor and social programs but likely positive for business and markets.
That leaves Emanuel Macron of En Marche, who politically is a bit of a cipher running for his first elected post. He is a technocrat and has held appointed economic roles, and his politics seem to thread the needle between the left and right. In terms of our Europe thesis, his election would probably be the best outcome because he is clearly pro-Europe, pro-growth and slightly liberal but with a bit of Fillon’s pragmatism. More than anything else his problem is that he is just not exciting. On the heels of “Penelopegate” in his rival Fillon’s camp, there was a brief whiff of scandal for Macron with rumors of an extramarital affair, but, being France and true or not, this probably breathed some human interest into his campaign. The incumbent Hollande was probably never more popular than early in his term surrounded by the drama of his own affair.
On April 23rd, the first round of the French elections will take place and clear the field. With it highly unlikely there will be a decisive winner, we will see two candidates into the second and final round on May 7th. Which two candidates will tell us a lot about the likely direction France and its role in the EU will take. We could see the centrist Macron and the conservative Fillon as one probable contest and reinforce a pro-growth view of the region. But, a hard populist second round between the fringes with Le Pen and Melenchon could signal that any outcome may be their own spin on “France First” at the expense of the currency and the region. We will keep our table at the café, under the awning and chairs facing the street, watching.