Le Pen risk overstated: add to banks & France

Credit Suisse thinks the risk of a Le Pen victory is overestimated: The 30% chance priced in betting markets is too high.

We think the risk of a Le Pen victory is overestimated: The 30% chance priced in betting markets is too high in our view as: (i) Marine Le Pen would need a polling error more than 3x greater than that seen in the Brexit vote to win; (ii) Front National is much more of a fringe movement than the Trump or Brexit campaigns; (iii) polls indicate Emmanuel Macron will make it through to the second round as he is occupying the centre ground, while the risk of a left-of-centre alliance is diminishing. Even if Le Pen wins, she would likely have very limited powers, making it extremely unlikely that she could pass a referendum on the EU. Opinion polls suggest that even if a referendum were held, a large majority would vote to remain.

The fundamental weaknesses of the euro area remain, but Italy is the weak link, in our view. In Italy, 57% of the electorate support Eurosceptic parties. Moreover, Italy has the most overvalued real effective exchange rate and has the worst growth record in the Eurozone (-0.4% GDP p.c. CAGR since 2000). Even here, some surveys suggest reasonable support for monetary union, and it appears unlikely that Eurosceptic parties could control the Senate (which would likely veto a referendum).

We add to European banks. Unlike the US, European banks have significantly lagged non-financial cyclicals (which are pricing in c3% GDP growth). Banks are the most correlated sector to bund yields, which should rise as political risk diminishes. P/E and yield relatives are mid-range but earnings/dividend momentum is at an 8-year high. French banks remain cheap with a yield premium marginally above its norm relative to European banks; our analysts highlight CASA. Life companies should benefit from the yield curve steepening, with tapering expected prior to a deposit rate hike (AXA).

We take French equities to a small overweight from benchmark, having upgraded to neutral in December. The P/B discount relative to euro area equities (ex. financials) is at a 20-year low; INSEE data is consistent with 2% GDP growth; earnings revisions are positive relative to Europe for the first time since 2011; and a centrist victory would likely usher in reform. Stocks with high French exposure that have underperformed their European peers YTD and are cheap on HOLT include Kingfisher, Orange, Thales and AXA. Elsewhere, euro area equities would likely be a big winner from a Le Pen defeat, and we reiterate our overweight stance and 3,500 mid-year target for the Euro Stoxx 50. They are on a 21% P/E discount to the US; growth differentials imply 17% outperformance and earnings revisions are strong.

Cheap hedges on a Le Pen victory: We would be cautious of French corporate credit; we think French bond yields rise under any outcome; Italian bond spreads widen relative to Spain (which could be played via the regulated utilities or concessionaries); and overweight German real estate. A Le Pen victory coupled with full implementation of her policies (a very low probability) could, in our view, see European equities fall c25%, for reasons we discuss.

Equity Research – Credit Suisse