As we close the books on the first half of the year, investors appear satisfied with where we are in terms of the global economy and progress on inflation. Some countries have started to lower policy rates, helping to push the recession narrative aside for now and, when the second quarter earnings results begin to roll in, analysts do not anticipate much in the way of negative news. With the U.S. election just over four months away, the French going to the polls this weekend and a UK election next week, the focus has now shifted to how political developments might affect market sentiment in a possible void of economic or corporate surprises.

 

In both countries, the election calls came as a surprise to not only outside observers, but even those within the respective parties. They are months, if not years ahead of schedule. If PM Sunak’s conservative party and President Macron’s Renaissance party were enjoying a commanding lead in public opinion polls, then the snap election calls may have made sense in terms of solidifying parliamentary or national assembly control. Neither is the case.

 

At the time of writing, polls showed both parties trailing. According to Reuters, the latest Ipsos poll had the far right National Rally party in front with 35.5% of the vote, followed by 29.5% for the left wing New Popular Front alliance and then Macron’s alliance party with 19.5%. For the UK, the latest Ipsos Political Monitor poll has voting intentions for the Labour party at 42%, versus 19% for the conservatives and 15% for the far right wing Reform UK party. Aside from the respective rationales for calling these elections with popularity so low, the outcomes could have implications for the future economic paths of both countries and market developments.

 

 

Equities for one, do not respond that well to uncertainty and the respective benchmark indexes for these two countries highlight that. The above chart shows the UK FTSE 100 index versus the French CAC 40. From this time last year, the FTSE has advanced by about 9% and it is up just shy of 6% since the start of this year. The CAC 40, however, has seen only a modest gain of 3% from the start of July in 2023 and is basically unchanged so far this year. There are a number of factors that that explain this divergence, but investors are focusing on post-election policies from the vantage point of growth.

 

In the case of the UK, while it is true that markets generally will prefer conservative governments (lower taxes, less government, etc), economic growth has definitely been lacking in the years since Brexit and the pandemic. There have  also been fiscal mis-steps and, more recently, not so positive revelations outside of policy. Market pundits, however, do believe that a Labour government will be more focused on growth and, if that materializes, this should be reflected in valuations for UK stocks all other things being equal. Keep in mind also that the Bank of England has started to trim interest rates and even a modest move lower in rates into 2025 should provide an added tail wind.

 

In France, the minority coalition has created gridlock in the assembly, resulting in most policies being enacted through presidential action. There is a limit to how far the president can go, specifically when there is cohabitation (when the president and government stake the stance of different parties), in this case it really is the prime minister and government heading up economic policy and other domestic relations. Post-election, it is still not clear whether the National Rally party will command an outright majority. If it were, or if somehow a centrist coalition can be spliced together, then there may not be a dramatic departure in economic policy to the extent that markets would be concerned. A larger left wing coalition, however, would raise concerns over things like minimum wage increases and tax hikes and the latter worries have been reflected in markets more recently.

 

 

What of the bond market? Here, the difference in UK and French government bond performance has also been quite dramatic. Prior to the snap election call by Macron, bonds were actually not doing too bad, as inflation showed signs of cooling. The spread between the French government 10yr yield and the comparable German yield was hovering in the 0.4-0.5% range ahead of June. That spread has spiked out to three-quarters of a percent in recent sessions on a perceived increase in fiscal risk and/or broader euro concerns.

 

Spreads between 10yr UK gilts and German bonds are still considerably higher than current French spreads, but have moved in appreciably over the past year. Again, one would typically think of a Labour  election win as being somewhat negative for bonds, but we are coming from a fiscal calamity a couple of years ago and investors still recall the last Labour government under Tony Blair, when the fiscal situation was actually in pretty sound shape.

 

 

Any major decisions with respect to allocating more or less to these two countries would benefit from a more clear understanding of the true lay of the land in terms of government make-up and actual policy decisions. We have been neutral weight in terms of our equity exposure leading into these events, while the allocation to French bonds has been minimal. At our next conference call, a couple of weeks from now, we will be able to provide added clarity…hopefully.

 

On behalf of the Pyle Wealth Advisory team, have a wonderful Canada Day weekend.   

Andrew Pyle

 

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Andrew Pyle is an Investment Advisor with CIBC Wood Gundy in Peterborough. The views of Andrew Pyle do not necessarily reflect those of CIBC World Markets Inc.

 

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