Perspectives Europe: a French economic evolution

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By Katrina Dudley, CFA, Investment Strategist, Portfolio Manager, Franklin Mutual Series

Franklin Mutual Series’ Katrina Dudley sees the re-election of President Emmanuel Macron as positive for the French economy and regional stock markets in the longer term term.

A potential economic and political revolution in France and in Europe has been avoided. President Emmanuel Macron won a decisive victory over Eurosceptic populist Marine Le Pen in the second round of French elections on April 24.

The results should allay immediate concerns about potential cracks in NATO and European Union (EU) efforts to forge closer ties to respond to Russia’s devastating war in Ukraine.

We also expect the market-friendly Macron to tackle high cost-of-living inflation resulting from rising energy and food prices, which should be positive for the world’s second-largest economy. the region and broader regional stock markets.

Dealing with a cost of living crisis

Macron faces significant economic challenges at the start of his second term. The war in Ukraine pushed already high European energy prices even higher. Europe imports around 40% of its natural gas and nearly 30% of its crude oil from Russia, according to data from regional statistics compiler Eurostat.1 Fears over the region’s lack of energy independence and potential supply disruptions have made regional energy more expensive over the past two months.

Given the importance of oil to the global economy, rising prices could hurt economic output. Europe has rushed to find new supplies from the United States and Qatar to reduce its dependence on Russia. Some countries, such as Germany, have been reluctant to cut Russian gas imports immediately, while others are aiming for the end of 2022 to stop using Russian energy.

Food prices, which began to rise last year, are a growing concern in the region. Russia is a major exporter of fertilizer, a key input into agricultural production, and Russia and Ukraine are major exporters of wheat. Supply disruptions resulting from the war are driving up the prices of grain and other foodstuffs.

European consumers felt the pinch. As inflation remains higher for longer and trade remains disrupted, we could see further demand destruction and a weakening of the European economy in 2022. In response to these pressures, we expect what Macron’s budget focuses on supporting workers and protecting households against rising prices and a potentially more fragile economy.

Another risk is the political ramifications of a weakened economy and higher prices. The French presidential election, which saw the defeat of the populist candidate, was not a full term for Macron as Le Pen improved his vote share five years earlier and the more far-left and extreme parties right did surprisingly well in the first ballot.

These gains are further underscored by growing support for populist parties, from Spain to Hungary, as economic anxiety mounts. Macron’s next political test will come in the June legislative elections.

Focus on the future

In addition to tackling rising prices, we expect Macron to spearhead other potentially beneficial initiatives. The first is to push labor market reforms further and propose changes to the country’s unemployment insurance system. The new government will also need to reach consensus on pension reform, although we expect any changes, such as raising the pension age from 62 to 65, to be gradual.

Macron should also focus on reducing corporate taxes and investing in key sectors for the future to boost long-term economic growth. Many of these investments have a “green” slant, such as retrofitting 700,000 homes a year to reduce energy consumption.

Some of the green efforts are part of a wider EU strategy to improve the resilience of the energy supply, particularly given the challenges the region faces in weaning itself off Russian natural gas.

Europe’s move towards greater renewable energy production was well underway before the Ukraine crisis, and the need for such a program has become more pressing since the start of the war. We believe the region will need to continue to invest in local renewable energy and find a balance between responsible climate management and responsible energy security.

On the business margin

France’s business-friendly policies could help mitigate some of the impact on corporate margins from rising energy, supply chain and logistics costs resulting from the war and the lingering effects of the pandemic.

Initially, the question for companies was whether they had sufficient pricing power to pass on these costs. Now, however, there is a balancing act. The cost increases are so substantial that companies must weigh the price increase against the possibility that it will hurt demand if they go too far. At the same time, they must consider the likelihood that they will hurt profits if they do not, or cannot, fully pass on the higher costs.

Meanwhile, attempts to bring manufacturing closer together and strengthen supply chains that began during the pandemic are expected to accelerate over the next few years. Investing in greater supply chain flexibility means reassessing the risks of locating factories in remote and undemocratic states.

Companies also assess resilience beyond their immediate suppliers; they are now interested in the resilience of suppliers vis-à-vis their suppliers. As a result, we would expect to see companies building facilities closer to home and in places with lower potential political risks, a potential boon for automation companies helping relocation.

Uncertainty related to the bitter war in Ukraine and growing inflationary pressures are likely to continue for the foreseeable future. Ultimately, we expect to see a Europe that is more united and economically and environmentally sustainable, and better able to withstand external shocks.

Given France’s importance within the EU, we believe Macron’s re-election reinforces this positive outlook. We believe investors should benefit from a stronger Europe and that recent market volatility has only increased the potential for finding deeply discounted long-term value opportunities.

What are the risks ?

All investments involve risk, including possible loss of capital. The value of investments can go down as well as up, and investors may not get back the full amount invested. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Investments in foreign securities involve special risks, including currency fluctuations, economic instability and political developments. Value securities may not rise in price as expected or may still fall in value.

1. Source: Europa.eu, “Where do we import energy from?

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Editor’s note: The summary bullet points for this article were chosen by the Seeking Alpha editors.

Mary I. Bruner