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The French Government Collapses…and French Stocks Rally. What Gives?

August 26, 2014 | About:

The French government collapses amid petty infighting over the weekend…and French stocks rallied on Monday. That says a lot about the market’s perception of the people running France.

French stocks have taken a beating of late; the iShares MSCI France ETF (EWQ) spent most of June and July in correction, dropping about 14% peak to trough on a string of lukewarm economic news, geopolitical tensions in Ukraine, and some good, old-fashioned profit taking. But since early August, French stocks have been quietly rallying, and the change in government offers hope that investors may be reevaluating the Fifth Republic.

Let’s take a look at France and at French stocks. If the recovery in the Eurozone is to get a second wind, the bloc’s second-largest economy needs to play its part.

What happened over the weekend?

This requires a little background. France, like the United States, has an executive president. This is in contrast to a British-style parliamentary system in which a president or king serves as a figurehead and real executive power rests with the prime minister. But France is quirky in that it also has a prime minister that nominally leads the government.

So…why would a country have both an executive president and a prime minister? That’s easy. It gives the president a “fall guy” to fire when things aren’t going particularly well and insulates the president himself from political fallout. It gives the president the perception of being above the political fray.

In the present case, Economy Minister Arnaud Montebourg—one of the harder-left members of the cabinet—had been openly criticizing the modest attempts at pro-market reforms by Prime Minister Manuel Valls. French President Francois Hollande effectively fired Montebourg—and the rest of the cabinet—and the general consensus is that the new cabinet being formed, with Valls again serving as prime minister, will be more market friendly.

Why the sudden shift towards pro-market policies?

France is in a rut. The unemployment rate is nearly 11% and economic growth has flat lined. France’s budget deficit will finish the year well above the EU’s targeted cap of 3% of GDP. Hollande is widely viewed as an ineffective president and has an approval rating of just 17%, and his frequent policy reversals have eroded business and consumer confidence.

Why are French stocks rallying?

If France is such a mess…why are French stocks rallying? The simplest answer is that the summer correction has simply run its course; stock prices had been reset by two months of declines.

But digging into the numbers, French stocks are not unattractive. French stocks trade at a cyclically-adjusted price earnings ratio (“CAPE”) of about 14. This is about 25% below the long-term average for French stocks. And remember, French politics and economy have been a mess for decades; it’s hard to see why today’s situation warrants a 25% discount, particularly given the low level of interest rates (according to standard formulas, low yields mean higher stock market valuations, all else equal). As a point of reference, U.S. stocks are currently priced about 25% over their long-term CAPE.

And this might come as a surprise to many readers: socialist France has become quite shareholder friendly of late. French stocks have raised their dividends by about 30% over the past year, well over the European average of just under 20%.

The iShares MSCI France ETF is loaded with world class multinationals, such as oil major Total (TOT), health giant Sanofi (SNY) and fashion giant LVMH Moet Hennessey Louis Vuitton (LVMUY). France’s politics are a mess—and frankly, they have been since the age of the Bourbon kings. But French stocks look like an attractive option given the pricey alternatives on this side of the Atlantic.

About the author:

Charles Sizemore
Charles Lewis Sizemore, CFA is the Chief Investment Officer of Sizemore Capital Management. Please contact our offices today for a portfolio consultation.

Mr. Sizemore has been a repeat guest on Fox Business News, has been quoted in Barron’s Magazine and the Wall Street Journal, and has been published in many respected financial websites, including MarketWatch, TheStreet.com, InvestorPlace, MSN Money, Seeking Alpha, Stocks, Futures, and Options Magazine and The Daily Reckoning.

Visit Charles Sizemore's Website


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