A clash of opinions on France is developing, and it’s not directly related to the current political uproar over the government’s proposed budget. Investors are increasingly divided on whether France is a promising prospect, and the identities of the opposing camps will surprise you, writes Nasdaq Advisory Services' European-equities analyst Nicolas Hourcard in this Op-Ed article in The Wall Street Journal.
There’s little debate that the French economy today is fragile. The country’s budget deficit is set to reach 4.4% of gross domestic product at the end of this year, far from the Brussels-imposed target of 3% by 2015, while unemployment is expected to remain at an all-time high. Standard & Poor’s recently cut the country’s credit outlook to “negative” from “stable” due to the struggling recovery.
Yet France is still able to borrow at record-low interest rates while the country’s CAC 40 stock index has so far this year outperformed the FTSE 100 and DAX 30. With its price-to-earnings ratio at a premium compared with peer markets, the French economy does not appear to be undervalued.
The surprising thing is that it’s not the French who are buying. According to aggregated Nasdaq Advisory Services data, French investors have greatly reduced their exposure to CAC 40 companies, resulting in an aggregate 4.2 billion-dollar decrease in the value of shares held domestically from the end of December 2013 to the end of June 2014. During that period, French institutional sellers accounted for 19.2% of the overall net sellers, most notably driven by Amundi and Natixis , the 11th- and 14th-biggest asset managers in the world.
Two factors help explain this domestic pessimism. First, France displays a challenging mix of macroeconomic components. Unemployment rose for the nine months prior to July 2014, with zero growth in the first half of the year. The country has also witnessed decreasing inflation and recurrent contractions in manufacturing activity, while the government’s debt-to-GDP ratio reached 91.8% at the end of 2013. Deflation would have serious consequences, effectively increasing the burden of this enormous debt pile. French investors have thus become wary of investing in French companies, whose trading performance is connected to the country’s economic health.
Second, President François Hollande ’s leadership has been undermined, with his approval rating falling to historic lows. Over the past two years, Mr. Hollande’s lack of supply-side reforms, combined with massive tax increases, have led France to a political stalemate. Meanwhile, European Parliament elections in May saw the victory of Marine Le Pen, leader of the National Front. The increased influence of this populist party, which opposes the euro, damages France’s credibility and reputation in the eyes of its European partners. Such political shocks lead to uncertainty, which is perceived negatively by domestic investors.
Instead, optimism in France is driven by foreigners, and especially Americans. Investors in the US increased their holdings of French stocks by $1.9 billion during the first six months of this year. Growth investors—funds that seek companies likely to grow above industry trends—account for $896 million of that buying.
In this respect, France is partly a beneficiary of broader monetary-policy trends. European markets excluding the U.K. saw an inflow of 21.3 billion dollars of US capital in the first half of this year, according to Nasdaq advisory and Lipper, a fund-data provider. The low-yield environment created by the U.S. Federal Reserve’s extraordinary easing policies has made Europe more attractive. European shares also appear undervalued with respect to their counterparts in the U.S., with a cyclically adjusted price-to-earnings ratio of 14.0 in the former market compared to 25.89 in the latter. The fact that the largest increase in dividend payments in Continental Europe during the second quarter of 2014 came from French companies makes them especially attractive to U.S. investors.
Americans also are betting that the European Central Bank will deliver policies in line with the increasingly dovish tone it has adopted this year. Speculation has intensified regarding the start of a new quantitative-easing program in the euro zone, following the euro’s appreciation during the first six months of 2014 and recurrent low inflation. As seen in Britain, the US and Japan, QE pushes long-term bond prices up (and, inversely, yield down), while also encouraging investors to invest in equities. ECB President Mario Draghi ’s bold move last month to announce that the central bank will start buying asset-backed securities as a form of QE has led markets to believe easier money is on the way. This new stance might lure more foreign investors into the euro zone market.
Read more of this opinion article in The Wall Street Journal.