Markets have reacted positively to Emmanuel Macron and Marine Le Pen going forward to the second round of the French presidential election on 7 May. Polls on the second round now show establishment figure, Macron, ahead of Le Pen by more than 10 percentage points. There’s an overwhelming likelihood of Macron being the next French president, notwithstanding another ‘surprise’ election outcome.
An ultimate Macron victory would remove the downside tail risks associated with ‘Frexit’, be supportive of the cyclical upturn in Europe and provide upside potential from his structural reform agenda. This direction of travel is good news for European equities and removes some of the political risk that kept investors on the sidelines. It will be easier for them to now refocus on the fundamentals.
The macroeconomic backdrop in Europe is very robust: economic leading indicators, such as the PMIs, continue to show positive momentum and are consistent with European growth of near 3%. GDP growth this year could – like last year – be stronger than that in the US. All country economies have emerged from deflation and earnings momentum is strong, with breadth of upgrades at a 6-year high and better than those in the global market.
The valuation case for Europe illustrates potential upside from earnings growth and a higher multiple put on those higher earnings. Relative to the US, Europe is attractively valued with 5% and 19% upside potential to 20-year average relative PE and PBV (price to book value) multiples. Importantly, rebounding EPS in Europe provide a platform for outperformance, but year-to-date Europe has actually de-rated versus the US.
It’s likely that lower tail risks and recovering investor flows will support multiples here. Even before the French election, there was evidence of a rotation of funds into Europe at the expense of the US. This could now be expected to gain momentum. European markets are showing resilience, but political risk could continue to dominate sentiment in 2017 with elections still to come in France (second round), the UK and Germany.