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Market Update
2017
French Elections: Basics for Investors
Julien-Pierre Nouen, Vice President, Lazard Frères Gestion, Paris1
The French presidential elections—which are scheduled for April and May—have already defied expectations. Just last summer,
the incumbent President François Hollande from the Socialist Party was expected to run for re-election. The only outstanding
question at the time was whether he would face Nicolas Sarkozy or Alain Juppé for the conservative Les Républicains. Today,
the socialist and conservative parties, which have governed France for decades, look likely to be eliminated in the first round of
voting. This would leave the second round contest to Marine Le Pen, a right-wing populist, and Emmanuel Macron, a relatively
new figure in French politics who positions himself at the center of the political spectrum. A Le Pen victory could potentially
cause a significant risk-off reaction in the financial markets, but we believe that scenario remains unlikely. Nevertheless, the
widening spreads between French and German bonds seemingly show that markets have started to take this risk into account
(Exhibit 1).
Many market participants have justifiably focused
their attention on the upcoming French presidential
elections. There is the tail risk that the new French
president could bring about a referendum concerning
France’s possible withdrawal from the European
Union. However, it is more likely, in our view, that
a more centrist winner will seek to reform France,
which could be positive for Europe’s markets and
politics. In this paper, we review the contenders, their
agendas, their likelihood of winning, and explain why
the parliamentary election—scheduled in June—may
be even more important than the presidential election.
We also discuss the potential risk of the so-called
“Frexit” and describe a baseline scenario for a centrist
president who would look to address some of France’s
structural headwinds.
Exhibit 1
Markets Appear to Be Taking Account of Election Risk
French vs. German Spreads (bps)
150
100
10-Year Yields
50
0
2-Year Yields
-50
2007
2009
2011
2013
2015
2017
As of 7 April 2017
Source: Bloomberg
The Contenders
The official list of French presidential candidates numbers eleven, but only five are currently polling above 10% (Exhibit 2).
Based on polls at the time of writing, Marine Le Pen and Emmanuel Macron are likely to make it to the second round, where
Emmanuel Macron is the favorite to win. However, we note that a large number of voters appear to remain uncertain of their
choice.
Marine Le Pen took over the far-right National Front party from her father, Jean-Marie Le Pen. She has been largely successful
at broadening the base of what was before principally an anti-immigration party. She adopted a statist, anti-globalization,
welfare-enhancing stance that has helped the party win many votes among working class voters. Her platform is best
summarized by her stated willingness to force France’s exit from the euro zone. She has also stated that she would like to roll
back a significant amount of the latest liberalization measures put in place.
LR28166
2
Benoît Hamon, the candidate of the Socialist Party, defeated
former Prime Minister Manuel Valls in the primaries. He stands
on the leftist wing of the Socialist party and his platform is based
on the idea of tax and spend. He has stated that he would like to
reform the Stability and Growth Pact to allow for more spending
and some renegotiation of debt in Europe. His main idea, the
creation of a universal income, has been watered down, but it
retains support from the reformist wing of the socialist party. Some
members of this wing have already joined Emmanuel Macron;
others have openly voiced criticism of Hamon’s political views.
First Round
(%)
Left
Right
30
20
10
Jacques
Cheminade
Marine Le Pen
François
Asselineau
Nicolas
Dupont-Aignan
François Fillon
Jean Lassalle
Emmanuel
Macron
Benoît Hamon
Jean-Luc
Mélenchon
0
Philippe Poutou
Emmanuel Macron is something of a novelty in France. He is the
first candidate since Charles de Gaulle that is likely to make the
second round of the presidential election without ever holding
an elected office. He started as an advisor to François Hollande,
was designated minister for economy, and resigned last summer
to launch his bid for the presidency. He has positioned himself
at the center of the political field. The Nordic model inspires his
platform: he wants a more flexible labor market and, at the same
time, broader welfare protection. His program also aims to reduce
the weight of the state in the French economy.
Exhibit 2
Polling Averages
Nathalie Arthaud
François Fillon is the candidate for the right-of-center Les
Républicains through primaries late last year. His platform to
improve growth and public finances draws inspiration from
Margaret Thatcher’s transformation of the United Kingdom: e.g.,
lower taxes—especially for corporations, less workers’ protection,
and a significant reduction of the number of civil servants. Fillon is
the most politically experienced candidate—he was prime minister
under President Sarkozy—but he faces legal charges for allegedly
providing a fake job to his wife. The clear frontrunner before the
scandal, his ratings have since fallen dramatically, leaving him third
in the polls.
Second Round
(%)
60
50
40
30
20
10
0
Emmanuel
Macron
Marine
Le Pen
François
Fillon
Marine
Le Pen
Average of latest poll data collected through 31 March 2017
Source: Cevipof, Harris Interactive, Ifop Fiducial, Kantar Sofres, Odoxa, Opinionway
Jean-Luc Mélenchon is the most significant candidate of the far left. A firebrand and consummate public speaker, he believes the
Socialist Party is on the verge of disintegrating, and wants to be at the center of the rebuilding process. He wants to roll back recent
liberalization reforms and increase public spending. He is also much more skeptical of the European Union than Benoît Hamon, as he
also supports a referendum on the euro and an exit from NATO. His good standing in the TV debates has helped him overtake Benoît
Hamon in recent polls.
The Presidential Election Is Drawing Attention, but the Parliamentary Elections Are
Probably More Important
The first round of the presidential election will take place on 23 April. The two leading candidates will then oppose each other in a
second round on 7 May. The presidential election has the highest estimated turnout: 80%–85% of eligible voters have participated in
past presidential elections, but polls are forecasting a record low level of participation as the French people are deeply unsatisfied with the
campaign. The victor takes office a few days later and nominates a prime minister, who is in charge of forming a government. On 11 and
18 June, two rounds of parliamentary elections will take place to nominate deputies to the National Assembly (Assemblée Nationale)—
the lower chamber. In the past, these elections have always resulted in a majority for the president’s party, but there is no guarantee this
will happen this time. Finally, in September, half the Senate will be re-elected through an indirect vote of grand electors (mostly local
government elected officials). The National Assembly has the power to rule on most governmental matters, but the Senate approval is
required to pass constitutional changes.
3
Each of the 577 National Assembly deputies is elected by a single-member constituency through a two-round voting system. The main
difference with the presidential election is that more than two candidates can stand in the second round, provided that more than 12.5%
of registered voters cast their ballot for them. In the past, thanks to this voting system, the bipolarization of French politics and political
agreements between parties on the same side have always led to clear majorities. But the French political system seems to be undergoing a
reshuffling, with the emergence of new political forces and deep tensions inside parties, such as the Socialist Party. As the French electorate
seems to be much more splintered, the elected president might end up without a majority of deputies to govern. Without a majority, three
scenarios could happen: a coalition, a minority government, or a “cohabitation.”
The first scenario is likely to happen if Emmanuel Macron is elected. Without a structured political party to support him—as his political
movement “En marche” is just a few months old—he might be short of a majority. He has already stated that he would be willing to rely
on a coalition of the willing. The National Front is still seen as “toxic” by a majority of the French population and, even if the party was
boosted by the election of Marine Le Pen, it would very likely fall short of a majority. The second scenario occurs when minority parties are
unable to unite against the party with most votes. The party with the most votes might govern with the abstention of a somewhat important
portion of the opposition parties, as is happening now in Spain. The last scenario, where the president and the government are not from
the same political party, has happened three times when the presidential mandate was seven years long (in 1986–1988, 1993–1995, and
1997–2002)—but never since the presidential mandate has been shortened to five years to coincide with the parliamentary mandate.
Those “cohabitation” experiences are interesting as they show that the French presidency, despite representing one of the most powerful
elected offices in the world, is in fact left with few powers without parliament on its side. As the parliament has the ability to overthrow the
government through a vote of no confidence, a refusal by a president to select a prime minister from the winning party would likely lead to
gridlock.
The Real Risk: Will France Go down the Road of Frexit?
Both François Fillon and Emmanuel Macron appear to be market-friendly candidates. Both are also committed to significant reforms of
the French economy, although with different flavors. As mentioned earlier, Fillon has more of a Thatcherite political platform, whereas
Emmanuel Macron’s political platform appears based on the Nordic model. Unlike other candidates, both have stated a desire to cut the
deficit and to bring down debt, which is still relatively high (Exhibits 3 and 4).
Despite a recent surge, current polling suggests that candidates from the far left are unlikely to pass the first round of voting. The scenario
that appears to worry the market is the election of Marine Le Pen, as it would likely set France in motion towards a referendum on
membership of the euro zone, causing investors to worry about the potential risk that their euro-denominated assets might suddenly become
franc-denominated.
Based on current polling, it appears that Marine Le Pen will easily reach the second round but she is likely to lose against other major
candidates. Nevertheless, in a politically charged environment, with voting intentions being more volatile than in the past, the potential for
a Le Pen victory cannot be totally discounted.
Exhibit 3
The Market Would Welcome Candidates Who Can Address
France’s Deficit
Exhibit 4
France’s Government Debt Is Another Economic Point
to Tackle
Government Net Lending as a Share of GDP (%)
Government Debt as a Share of GDP (%)
0
100
-1
Euro Zone
-2
France
90
Euro Zone
-3
80
-4
France
-5
70
-6
60
-7
2000
2003
2006
2009
2012
2015
2018
2000
2003
2006
2009
2012
2015
As of March 2017
As of March 2017
Estimated or forecasted data are not a promise or guarantee of future results.
Estimated or forecasted data are not a promise or guarantee of future results.
Source: AMECO database
Source: AMECO database
2018
4
A core part of her political platform is for France to reinstate the franc as its currency, as part of a wider push for sovereignty. Documents
released by her campaign insist that the exit would be negotiated and part of a complete overhaul of the relationships between France and
the European Union. Marine Le Pen has said that, under her presidency, France would try to negotiate an exit during a six-month period
before calling a referendum about Frexit.
Meanwhile, if elected, she has pledged to immediately launch a referendum on electoral and constitutional reforms. Amongst other
subjects, the proposed referendum would address the question of greater proportionality in electing the National Assembly. With a majority
premium, this would dramatically increase the probability of a National Front full victory in latter elections. This first referendum would
also modify the law on other referenda. Indeed, even if Le Pen wins the presidential election, the current voting system will make it very
difficult for her to win a majority and to implement her proposed platform.
As a consequence, several questions arise regarding Le Pen’s ability to call a referendum. Two articles of the French constitution provide the
legal basis for this. Article 89 is the most legally sound basis for changing the constitution but it requires the reform to be approved by 60%
of the Parliament (National Assembly and Senate together) or by a simple majority in each chamber and by a majority of the population
in a referendum. As the Senate is not likely to be won by the National Front, it follows that Marine Le Pen could not use Article 89.2
Alternatively, according to Article 11, a referendum can also be organized on a simple proposition from the government to the president,
followed by a discussion in the parliament. It was originally targeted to a specific number of subjects but not to change the constitution, but
Charles de Gaulle used it twice for this purpose in 1962 and 1969.
In 1962, he succeeded in changing the presidential election to a direct vote. Seven years later, his Senate reform was voted down, causing
his resignation. At that time, the constitutional council decided not to overrule the vote based on the principle that the popular vote carries
more weight. It is not solid legal ground to organize a referendum, but it might be the only way for Marine Le Pen to reach her goal.
Therefore, right after the opening of the new parliament, or sooner if an extraordinary session is called, Le Pen’s National Front interim
government would likely propose the first referendum. The government would probably be voted out by the parliament if she does not have
a majority, but as the vote can only take place 48 hours after the motion of no-confidence has been introduced, it would leave enough time
for the president to accept the referendum proposal and launch the process. The National Front party has stated that it wants constitutional
reform to modify Article 11 to enable the president and the government to bypass the parliament, if necessary. Modifying Article 11 would
considerably reinforce Le Pen’s ability, if elected, to hold a Frexit referendum that would otherwise have needed authorization through
Article 89.
At the end of the six-month negotiating period, without any agreement with the European Union, which, in our view, is the most likely
scenario, the National Front party has said that it would call for a referendum on the European Union membership. According to a recent
poll, 72% of French people want to stay in the European Union.3 Marine Le Pen has declared that if she lost such a referendum and France
stayed in the euro zone, she would step down.
At this time, we believe Frexit remains a very low probability scenario, but if the next elections were to increase its probability, markets
would certainly start to price it through higher risk premiums on French assets, especially French bonds. For equities, we note that 80% of
sales from the CAC 40 companies come from outside of France and 50% outside of Europe. As observed right after Brexit, share prices in
many British companies with significant foreign exposure, such as commodity producers or pharmaceuticals, adjusted relatively quickly with
currency movements by rising. On the contrary, companies geared towards the domestic market underperformed significantly. In France,
we believe domestic players could potentially suffer as well. For example, retailers might be under pressure, as their cost would increase and a
National Front government might pressure them not to pass these increases to consumers. Of course, financial institutions could also suffer
significantly because they would have to sell their holdings of French government bonds, whose redenomination would amount to a default.
The Base Line Scenario: A Reformist President Faced with a Structurally Challenged
Economy in a Cyclical Recovery
While we recognize the risks of a National Front victory, we believe it is more likely to end up with a president with a constructive reformist
agenda. These potential reforms would seek to address a series of structural headwinds that have held back the French economy. Over the
last few years, France generated average economic performance. It did not perform as well as the German economy, but it did not follow
Italy’s path of very weak growth (Exhibit 5). France is much less exposed to global trade than Germany, so it was less impacted by the
global financial crisis. Its economy was not as imbalanced as Spain’s, and its banking sector was in better shape, so it did not suffer as much
pressure during the euro zone crisis, but it did not rebound as much afterwards. However, this election may have a significant impact on
France’s economic status.
5
Exhibit 5
France’s GDP Growth Has Been Close to the Euro Zone
Average
GDP (100=2007)
Exhibit 6
Confidence Is Picking Up
Y/Y Change (%)
Index
6
125
3
110
0
95
120
Germany
110
France
Euro Zone
Spain
100
Italy
-3
90
80
GDP growth [LHS]
Economic Sentiment Index [RHS]
-6
65
1997
2001
2005
As of March 2017
As of 28 February 2017
Source: AMECO database
Source: Bloomberg
20
Denmark
Ireland
United
States
United
Kingdom
OECD
Average
Spain
Italy
Belgium
0
As of 2015
Data include employers’ and employees’ contributions.
Source: OECD
Exhibit 8
Generous Social Programs Lead to Elevated Government
Spending in France
Government Spending as a Share of GDP (%)
60
Health and Social Protection
Other
40
20
As of 2015
Source: OECD
United
States
United
Kingdom
0
Spain
High non-tradable goods and services prices also weigh on French
competiveness. The lack of competition and a high level of
regulation (Exhibit 9) has pushed up the cost of inputs for many
companies, putting pressure on exporters’ margins. These lower
margins also lower the internal financing of corporations, increasing
40
Belgium
The high labor cost can be explained by the fact that a large share
of the funding of the extensive social protection system comes from
social contributions, which increases the cost of labor (Exhibit 7).
This comprehensive social protection is one of the main reasons
why government spending is so high in France (Exhibit 8). As
in other advanced countries, aging is likely to exert a significant
pressure on government spending in the years to come.
60
Denmark
According to economic research, we believe this lack of
competiveness can be attributed to both cost and non-cost factors.
Apart from particularly strong sectors such as aerospace, luxury,
and wine, French exports do not have a lot of pricing power,
and cost competitiveness suffers from high labor costs and high
non-tradable goods and services’ prices.
2017
Social Contributions as a Share of Gross Income (%)
France
A challenge facing France is a lack of competiveness, which has
gradually eroded the macroeconomic balances of what was once a
relatively sound economy. This lack of competiveness is visible in
the evolution of the trade balance, where the deficit has a tendency
to increase as soon as domestic demand is buoyant. Despite the
combination of a very accommodative policy in a country with
solid banks, lower oil prices and a lower currency, growth has not
accelerated meaningfully over the last few years.
2013
Exhibit 7
Social Contributions Increase French Labor Costs
France
France is benefiting from the global cyclical uplift, with indicators
of confidence at the highest level since 2011 (Exhibit 6). The
European Commission expects French GDP growth to accelerate
from 1.2% to 1.4%. This has allowed the unemployment rate to
start falling but not as rapidly as elsewhere in the euro zone.
2009
Germany
2017
Sweden
2013
Sweden
2009
Germany
2005
Italy
2001
Ireland
80
6
their reliance on debt. Another consequence has been to divert corporate investment towards real estate instead of productivity-enhancing
capital expenditures. According to the World Robotics 2016 Industrial Robots report, the number of industrial robots shipped to French
companies last year was 15% of what was shipped in Germany and 50% of what was shipped in Italy.
These structural impediments are well known, but the will to address them has been lacking over the years. François Hollande, who
described himself as a social-democrat, had been elected on a very leftist program in 2012 (“My enemy is the realm of finance” being one of
his most successful mottos during the elections), started his term by increasing taxes significantly, which brought the French economy to a
halt. Subsequently, his government switched to more supply-side reforms to the dismay of many of his voters and of many socialist deputies
who termed themselves “frondeurs” (“the rebels”) and tried to oppose this turn. Emmanuel Macron was instrumental in this policy, which
culminated in the passing of the El Khomri law, enabling firm-specific working conditions agreement to take precedence over industry-wide
arrangements. Despite significant demonstrations, the law passed.
Exhibit 9
France Has a Heavier Regulatory Burden Relative to the Main
European Economies
OECD Product Market Regulation Index
More Regulation
1.6
1.2
0.8
0.4
United
Kingdom
Denmark
Germany
Italy
Belgium
Spain
Ireland
France
0.0
Sweden
The election of Emmanuel Macron or François Fillon, provided
they get a parliamentary majority to work with, could step up the
pace of reforms, which we believe would be a good thing for the
French economy and for French assets. It would also probably
hasten monetary policy normalization by the European Central
Bank (ECB). Other scenarios would be viewed negatively by many
market participants, ranging from the election of Benoît Hamon,
which would be mildly negative, to the election of Marine Le Pen,
a clear negative, and the election of Jean-Luc Mélenchon standing
in-between. The implications of a Le Pen victory were covered
in the preceding section, but as polls have tightened recently
between the four main candidates, the election of Jean-Luc
Mélenchon is now a possibility worth contemplating. Even if he
will also encounter difficulty gaining a parliamentary majority,
his anti-market views around high taxes and nationalizing private
enterprises can bring about further market volatility.
As of 2013
Source: OECD
Conclusion
The French elections matter because there is the potential to elect a party that would like to see France leave the European Union. While this
scenario remains improbable, in our view, it cannot be fully discounted. However, we believe there is a much more significant likelihood
that the elected president will be willing to reform France. The implementation of these reforms could put France in a better situation and
improve its standing with Germany, thus enabling a more balanced leadership for the European Union.
Within financial markets, if Marine Le Pen loses, we believe it could potentially lead to an improvement of European assets, as it would
clear the political timeline until the next Italian elections. Investors could thus focus on the improvement in the European economy and in
corporate earnings.
Market Update
This content represents the views of the author(s), and its conclusions may vary from those held elsewhere within Lazard Asset Management.
Lazard is committed to giving our investment professionals the autonomy to develop their own investment views, which are informed by a
robust exchange of ideas throughout the firm.
Notes
1 Lazard Frères Gestion is the French asset management subsidiary of Lazard Group LLC. Lazard Frères Gestion is operationally independent from, and its employees do not provide
investment advisory services to, Lazard Asset Management LLC. Mr. Nouen’s insights are offered for information purposes only.
2 Only half the seats of the Senate are to be renewed. As the National Front has only 2 senators out of 348, they would need to get all the seats.
3 Elabe, 9th March
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Published on 17 April 2017.
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