French actors, Italian script – how far can we fall?
Since the announcement of the dissolution of the French National Assembly on 9 June, the French market has seen a sharp fall compared to its European counterparts. From 10-13 June (inclusive) the CAC 40 lost 3.6% versus a fall of 1.4% for the Stoxx Europe 600. In bonds, the France 10-year versus Germany 10-year government bond spread rose by close to 50%, from around 50 to 75 basis points. It is thus back at 2017 levels, which at the time was partly a reflection of concerns about the outcome of the French presidential election. If the France-Germany spread were to widen further, the next point of comparison would be the 2011-2012 euro crisis when worries about the break-up of the eurozone were rife. At the time, Greece had defaulted on debt payments and the National Front (Front National) – the former name of the National Rally (Rassemblement National) – was pushing for France to leave the eurozone.
Can France’s financial position slide further? This is of course impossible to predict, given the wide variety of political scenarios and the potential for short-term market surprises.
Every situation is unique, but history does offer a few examples to help us answer this question. A recent episode that could be compared to the scenario of a protest coalition dominating the French National Assembly can be found in the 2018 situation in Italy, when elections in March of that year failed to provide an overall majority for any single group. The Five Star Movement (M5S) – a group defying classification with its social and sovereign demands – topped the polls with 32% of the votes, whilst the far-right Lega party took 17%. After weeks of negotiations, these two parties formed a coalition, with Giuseppe Conte as Prime Minister. There was a costly economic programme, with the introduction of a “citizens’ income” for low earners, together with tax cuts. The coalition held until August 2019 when Lega head Matteo Salvini walked out, forcing the resignation of the Conte government.
The reaction of markets was clear-cut – from the announcement of the coalition, the Italian index lost 10% versus the Stoxx 600 European in 6 months. The Italy 10-year versus Germany 10-year spread expanded by around 200 basis points, back to 2013 levels.
What happened next is even more illuminating. Within a year of December 2018, Italian equities had made up the lost ground against European indices. They closed the gap, just before hitting a new crisis with the lockdowns at the start of 2020. Italian government bonds suffered for longer. Whilst the M5S-Lega coalition was in place, the Italy/Germany spread stayed on a high plateau, making the already considerable cost of Italian debt even higher. As soon as the Lega left the coalition, the spread normalised.
Even if not an accurate predictor, these historical events are instructive, as they are based on the same market concerns – the risk of excessive debt. In light of this example, it seems likely that French equities – particularly those with revenue most sensitive to state initiatives – may continue to be penalised for some time if the National Assembly is dominated by protest parties. But the situation could normalise little by little if there is no significant impact on corporate activity. On the other hand, the impact could be harsher and longer-lasting for France’s debt and its ability to finance itself in the future. This will last for at least as long as the dominant political forces are in favour of spending plans that are not fully funded.
The market can easily live with the fact that government policy is not made on the stock market (in the words of de Gaulle). But the Italian episode teaches us that all policies of a highly indebted state inevitably remain dependent on the market, and that this dependency only increases with time. Ignoring this fact means becoming even more dependent in the end.
Final version of 14 June 2024 Alexis Bienvenu, Fund Manager, La Financière de l’Echiquier (LFDE)