(Bloomberg) -- French stocks enjoyed a brisk relief rally this week after months of underperformance. But this could turn out to be a blip as France’s political crisis is set to drag on while the country’s stretched public finances will keep long-term investors at bay.
In a year when most of the world’s major stock markets handed investors double-digit returns, France’s CAC 40 Index is in the red, down 1.5%, heading for its worst year of underperformance relative to other European markets in over a decade. That’s in large part due to President Emmanuel Macron’s decision to call a snap general election in June.
The failed gambit unleashed months of political infighting just as the country badly needed stable leadership to reign in a budget deficit that’s among the highest in Europe. With the government in tatters following a recent no-confidence vote and borrowing costs that recently surpassed Greece, ratings agencies are warning that France’s finances are now getting dangerously out of control.
“The situation could degenerate if the deficit or even projections of the deficit show a deterioration,” said Claudia Panseri, chief investment officer for France at UBS Wealth Management. “I think that insurers and banks will continue to underperform.”
French stocks have rebounded over the past seven days, marking their best showing since February, and some investors bet that most of the bad news could in fact already been priced in. Right-wing political leader Marine Le Pen gave market an extra boost when she said France could overcome government collapse to deliver a budget in “a matter of weeks” so long as the next prime minister is prepared to narrow the deficit more slowly.
Guy Miller, chief strategist at Zurich Insurance Co., said that due to the significant underperformance this year, French stocks are now becoming worthy of consideration. “France will eventually get through this,” he said. “The market will rally on the basis of that and you want to be positioned ahead of that.”
But many other investors think the relief rally won’t last and the CAC 40’s potential gains in 2025 will be capped. David Kruk, head of trading at La Financiere de L’Echiquier in Paris, attributed some of the recent stock gains to hedge funds covering short positions before the end of the year. There’s no fundamental movement upward, he warned.
Banks and insurers, which make up 10% of the benchmark, are a major driver of French stock underperformance because they are particularly exposed to high borrowing costs. BNP Paribas, Credit Agricole SA and Societe Generale SA had as much as 4% of total assets in French government bonds at the end of the first half, according to Bloomberg Intelligence.
Borrowing costs in France remain elevated compared with the rest of Europe, and any impact on the economy will hurt companies that cater to the domestic market. A Goldman basket of French companies with a high percentage of local sales has fallen more than 7% in 2024, more than double the losses on the benchmark. Goldman Sachs strategist Lilia Peytavin thinks that trend has further to run.
“It’s the domestic-exposed stocks that investors need to watch to gauge the political risk,” Peytavin said.
Any new prime minister will likely face the same financial squeeze that brought down the previous government, and there’s skepticism over how quickly the various parties can reach a deal. Once named, a new prime minister will propose a cabinet, appointed by the president, and then has to send a new 2025 budget bill to parliament by Dec. 21.
Moody’s Ratings said this week that the toppling of the government “deepens the country’s political stalemate” and reduces the probability that France’s public finances will be consolidated.
French stocks will “suffer further compared to other geographic areas,”, said Alexandre Hezez, chief investment officer at Group Richelieu in Paris. “The risk premium on French assets should remain high for many months.”
--With assistance from Macarena Muñoz and Sujata Rao.
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