No, I am still that same enthusiastic Financial Markets guy. I
haven’t changed my discipline. I haven’t lost hope and didn’t choose to get
into philosophy after seeing back to back shockers in global politics and
global financial markets. As an active participant in the financial markets, I
choose to make my way through these events.
You can’t stop the world from functioning! You can’t stop
evolution! Events happen. You need to make your way through it and emerge as a
winner in financial markets
-
Harsh Pathak
So….Still confused over that philosophical title on this post
which is dedicated to finance?
Without creating much confusion, let me reveal…. This post is
dedicated to Ms. Marine Le Pen – the pro-populist French Presidential election
candidate who, on April 23, 2017, emerged as one of the finalists for the
runoff on May 7, 2017. This post is about the bloodshed in the global financial
markets that will result once she gets elected to power.
After long theories and interpretations that I read on
Bloomberg and Financial Times on the most probable outcomes of the first round
of the French Presidential elections that were held on April 23, 2017,
yesterday’s results finally showed that Emmanuel Macron and Marine Le Pen
advanced to a runoff which shall determine the next French President. The
runoff is scheduled to happen on May 7, 2017.
It is the first time in the nearly 59-year history of
France’s Fifth Republic that both of the final candidates are from outside the
traditional left-right party structure. Mr. Macron, a former investment banker, abandoned traditional parties a
year ago to form his own movement with an eclectic blend of left and right
policies. He campaigned on a pro-European Union platform, coupled
with calls to overhaul the rules governing the French economy. Ms. Le Pen’s
success was a victory for people who oppose the European Union and for those
who want to see more “France first” policies.
With this, it has broadly
become a contest where French people shall choose between globalization and
populism. As I read Bloomberg news and FT in detail on this, Macron’s victory
on 7th May shall indicate the future of European Union’s integrity
to be in place, while his defeat and Ms. Le Pen’s victory seems to be, at the
moment, a sure exit of France from the EU, which is fondly being referred to as
Frexit by media and economists.
However, I am not a big
think tank on politics. All I can contribute in political arena is read the news
reports and get updates from market, analyse them, predict the scenarios and
utilize them in combination with my other fundamental and technical analysis of
financial markets to take positions on equities.
The future of global equity
markets – in developed as well as emerging economies is, as per me, sitting on
a big time bomb called the ‘Final Round of French Presidential Election’. The
final outcome of the May 7 voting can either burst the bomb or diffuse it.
But why after all is it a bomb?
A new paper from Sciences Po
and Cepremap, shared with the Financial Times, shows a clear division between a
“pessimist” France turned towards Ms Le Pen, and an “optimist” France put their
confidence in Emmanuel Macron. According to the research, when asked about
their expectations for the future, the individuals who were most pessimistic
were those most likely to vote for Ms Le Pen. In contrast, those most satisfied
with their life opted most often for Mr Macron. Cutting the long story short, statistical
models are predicting win for Macron, but his defeat is also not ruled out
completely.
Though there are statistical
models predicting Macron’s win, I would rather choose not to completely believe
them. This is because models are built on human interpretations and the use of
analytics (system-based) and this year everything that can amuse and surprise
anybody has happened in the 2017 French Presidential elections. From François
Hollande’s decision not to run for a second term to former Prime Minister
Manuel Valls getting defeated in the Socialist Party primary; from the rise of
insider-outsider Emmanuel Macron to the standout debate performance by far-left
candidate Philippe Poutou; from François Fillon’s rise, fall, and rise to
Jean-Luc Mélenchon’s last-minute surge. All these events have increased the
uncertainity of the outcome of the election.
So, the explosion is here – The case of Marine Le Pen winning the 2017 French
Presidential Election
Name of the victim – the Euro and the European Union
After the results of the
first round were out, the markets on Monday gathered optimism on the
possibility of Macron winning the final round of elections on May 7. The win of
Macron, who is a pro-Euro candidate, shall mean that the chances of EU collapse
shall be mitigated (or rather eliminated tentatively) as the chances of Frexit
get very weak because of his support for globalization.
As per the data from
Reuters, the Euro rose to day’s high of 1.0935 against the USD after closing at 1.0723 on the previous
trading day. It however slipped to 1.0863 against the USD at 16:15 hours IST.
Reaching to that day’s high means an advancement of 2% in the currency’s value.
If Macron wins, market
expectations for the EUR/USD in the range of 1.09-1.10 post the final round may
hold and this shall result in stabilization of the U.S. Treasury market. Also,
this win shall mean fading of credit risk in the Eurozone which means increased
flow of funds in its cheaper equity markets which shall further support the
EUR/USD.
They say, “When your
expectations are not met, you feel that everything has fallen apart.”
Stock market participants, according to me, face this situation in and out. The
Euro, as seen, has rallied on expectations of a Macron win. However, if Le Pen
turns out to be the winner and if market grapevine is to be believed, the euro
can slide down to 1.00 against the USD as the fears of Frexit may take over (as
was indicated by Le Pen in her campaigns).
It is they who make the
rally and it is the same them who are responsible for the fall. Expect wisely!!
Don’t torture yourself!!
-
- - Harsh Pathak
One of the main reasons sighted
is, if France, under the leadership of Le Pen, chooses to leave the EU and consequently
drops euro as its currency, then introduction of a new devalued national currency,
as indicated by Le Pen would give out a shocker to especially the bond markets.
The French state is expected to pledge to limit its fluctuations against the EU
currency basket to a maximum of 20 percent. The prospective devaluation
may prove to an immediate inorganic boost to the French economy, but the
foremost concern of investors in this case shall be the fear to switch to a
completely new currency.
A devalued French currency shall
mean increasing its competitiveness in the International financial markets and
shall reduce France’s debt in Euro terms. As per a Bloomberg report, Le Pen’s
adviser Bernard Monot said, “Government debt would be redenominated in the new
French currency and the state would seek to buy back the debt from foreign
lenders. France would meet all its obligations to secure the trust of lenders. The
Bank of France’s quantitative-easing program would generate about 100 billion
new francs a year for the government -- theoretically equivalent to 100 billion
euros ($107 billion) -- which would use the revenue to cover welfare payments
and to fund its industrial strategy. Between 30 percent and 40 percent of the
revenue would be used to repay government debt. France’s borrowing costs will
rise as result of this policy but not crazily”. He forecast that the yield on
10-year bonds would be between 2 percent and 3 percent.
However, 60% of the French
bonds are held outside France. S&P has already warned that any move to
repay debt in a new currency shall lend up France in a Default rating. On introduction
of the new French currency devalued against the Euro and repaying the bonds in
terms of that currency, French investors might not care as much, but investors
whose base currency is dollars or sterling or any other currency per se would
very much care as the base currency valuation of their holding could end up
being significantly less.
Economically weaker Eurozone
countries like Greece, Portugal and Italy may have a ripple effect on their
financial markets as well as the credit risk in the union rises with Frexit.
Market expectations indicate
that the chances of Le Pen winning the election are way too less. The only
reason why I am not eliminating the possibilities of her win are that the
significance of the models that are predicting Marcos’ win do not seem to be
reliant as there is still a lot of confusion in what the French are thinking. The
margins with which Macron won was also narrow though. Also, when I look to the
past 2-month yield spread between the German and France on 10-year sovereign bonds,
they indicate a completely different picture of market expectation.
As per the yield spread, investors
seem to have dumped the French bonds and instead bought German bonds, which
indicate that there is still an underlying room for Le Pen to win on May 7.
Source: Bloomberg
US Stock Markets
On Monday, after the first
round of French election results were out, the US stock markets also developed
optimism, with the US stock futures opening sharply higher as Dow futures
rallied by more than 200 points. Any disappointment on May 7 can severely
affect the Euro currency and the US stock markets as a whole as a result of panic
in the markets.
Talking about India
Le Pen’s win means
introduction of new devalued (against the Euro) French currency and a major
decline in the EUR/USD rate (remember my quote on expectations???). It also
means further breaking up of the EU. Now, India’s debt exposure to Europe is
16.5% out of the total USD 485 Billion external debt (as per reports of the Reserve
Bank of India as on March 31, 2016). We survived Brexit calmly – thanks to the
RBI policies set by the former central bank governor – Dr. Raghuram Rajan in
maintaining enough forex reserves and other measures as well.
India is one of the most
open financial markets in the world and though it survived the effects of
Brexit directly, it was indirectly affected by the spillover effect of the
financial markets throughout the world – thanks to globalization. And this time
the spillover effect could be huge, really huge. No…. Gigantic!!
Financial markets throughout
the world are going to get a major shocker if Le Pen wins and would result in a
global turmoil.
History has shown that once
big negative news start coming in, market participant develop a pessimistic outlook
on futures. I am still a new entrant in the financial markets, but to the
extent that I have seen and heard in the markets and then reading the history
of stock market events and outcomes, I have realized that market participants,
on a large scale, take position on stocks on the prevailing events so much that
they tend to become over-optimistic or over-pessimistic, depending on the type
of news. I remember the May 2014 elections in India when there was euphoria and
predictions of the Modi government to win with majority in the elections, big
and well known brokerage houses became so over-optimistic that they went on to
predict the benchmark index – SENSEX to touch the 35,000 mark by the end of
that same calendar year. It didn’t even touch the 30,000 mark that year. It was
in March 4, 2015 that SENSEX crossed the 30,000 mark, but didn’t even sustain
it. It took 2 long years hence to again touch the 30,000 mark and is still not
sustaining it and now many big brokerage houses predict the 40,000 levels! (You
see! Expectations!!) But, however, we are humans and financial markets, to a
considerable scale, show movement because of expectations of market
participants.
This time also, it will be
pessimistic expectations that will rule the financial markets in case Le Pen
wins. The U.S. economy and the stock markets have a history of sending shocks
to the global financial markets. This time also, it may be the case.
I am also expecting the
Indian stock markets to see some heat way forward. As per the present scenario,
not only India, but the world is very optimistic on the “India: A Growth Story”
with its (India’s) strong macroeconomic numbers, stable government that is growth-oriented,
robust monetary policies, robust stock markets, huge demographic dividend etc. The
U.S., Australia, New Zealand etc. are adopting the “country first” approach
which means that Indian youth may have to explore for domestic opportunities on
a large scale. This means the government may need to create enough job
opportunities at a good pace. This is, at present, not the case, which means
that India’s demographic dividend may soon become its demographic liability.
Returning back to the threat
that U.S. may pose to Indian financial market conditions, let us see the
following graph,
This graph shows that the ratio
of Market Capitalization of the S&P 500 Index to the U.S. GDP has been
rising to levels that were existing during the dot-com bubble. The same levels
are seen to be approaching at the moment since the Great Recession happened.
This may be an indication of the U.S. stocks being overvalued at the moment.
Any shock from the final
round of the French Presidential election (yes, the shock I am referring is the
win of Le Pen) will trigger a global financial market turmoil and can send the
U.S. stock markets back to the 2009 levels. We seem to be sitting on another
possible recession, this time from the present EU. And, any shock in the U.S.
means ripple effect in the rest of the world.
Le Pen has also indicated a
6-month EU exit timeline once she assumes power and then the introduction of
the new devalued currency in the country, which shall be responsible for all of
the above.
Let’s see if Le Pen can
prove mightier and lead to a bloodshed in case she ‘writes’ France’s future. Or
would Macron be able to diffuse the ‘bomb’.
- Harsh Pathak
President - Finance Club, MISB Bocconi - Bocconi India
About the author,
Harsh Pathak is a student at MISB Bocconi (Bocconi India) and the president of Finance Club of the institute. He has immense interest in financial markets and runs his own analysis on Indian stock markets on a daily basis. He can be reached at,
Phone: +919820976480
Email: harsh.pathak@misbbocconi.com
Facebook: https://www.facebook.com/harsh.pathak.1048
LinkedIn: https://www.linkedin.com/in/harsh-pathak-2a960559/
