Goldman and Citi see European stock rally surviving French drama

by Sagarika Jaisinghani and Alice Atkins 

The risk of another failed government in France is already priced in by markets and won’t be enough to derail the best year for European equities relative to US stocks in almost two decades, according to top Wall Street strategists. 

While French Prime Minister Francois Bayrou’s surprise decision on Monday to call a confidence vote over a budget showdown has rattled investor sentiment, market strategists at Goldman Sachs Group Inc., Citigroup Inc. and JPMorgan Asset Management said contagion risks to the rest of Europe are low given historic fiscal reform in Germany and a resilient economic growth outlook for the region overall. 

Europe’s internationally exposed sectors such as luxury goods makers also stand to benefit from easing global trade tensions. After an initial selloff, some of the largest CAC 40 stocks, including LVMH, Hermes International SCA and L’Oreal SA, have already recovered this week’s declines. 

“It’s easy to say another political crisis means ‘sell Europe,’ but the fundamentals are already pricing in bearish scenarios,” said Beata Manthey, a strategist at Citigroup. “The case for Europe has always been based on Germany, which remains intact, while French assets are pricing in some political risk premium.” 

The Stoxx Europe 600 Index has beaten the S&P 500 by nearly 13 percentage points in dollar terms this year, the most since 2006, driven by Germany’s massive spending plans, a stronger euro and a flight from US assets in the first quarter. While the benchmark has struggled to top its March record as investors flocked back to US Big Tech in recent weeks, investors are now more optimistic about Europe’s economy. 

Goldman strategist Sharon Bell said the bank’s economists see no impact on growth from the political crisis in Paris for now. “There doesn’t seem to be a big concern within the context of the European market,” she said. “This is certainly within the scope of people’s expectations. The vulnerability of France was always there.” 

The CAC 40 slumped as much as 3.3% in two days after Bayrou’s move, while the yield spread between French and German 10-year debt hit the highest since April. By Wednesday, some of the declines appeared already contained. The Paris benchmark index gained 0.4%, while the Stoxx 600 index was steady after two days of losses.  

Some of that resilience is being driven by an improvement in Europe’s long-term earnings outlook despite higher US tariffs. Data showed the euro area’s private sector grew at the quickest pace in 15 months in August as manufacturing exited a three-year downturn. 

At the same time, relentless downgrades to earnings estimates since mid-March have set the stage for analysts to begin raising forecasts, according to Sophie Huynh, portfolio manager and strategist at BNP Paribas Asset Management. Upbeat economic data and an improving outlook in China are “more important” than political uncertainty for the market’s trajectory, she added. 

“If anything, we might see good entry points in European stocks,” Huynh said. 

The biggest impact from political events in Paris has so far been in the bond market, with the spread between French and German 10-year yields widening to 80 basis points for the first time since April. PGIM Fixed Income said that gap has, in fact, made French yields look attractive compared with US Treasuries.  

“We cannot deny that risks have increased and the market is clearly showing some signs of anxiety, but it’s nothing that we are not used to when thinking about France,” Guillermo Felices, global investment strategist at PGIM Fixed Income, said on Bloomberg TV. 

JPMorgan Asset Management also sees a potential buying opportunity if the spread rises to 85 basis points, as Germany’s looser fiscal policies will likely stop the gap from widening further, according to Iain Stealey, chief investment officer of international fixed income at the money manager. 

In currency markets, too, traders see little risk of the domestic turbulence spilling over into the broader euro area. Contracts that will pay out if the common currency resumes gains saw high demand on Tuesday, data from the Depository Trust & Clearing Corporation showed. 

This week’s turmoil is a sequel to June 2024, when President Emmanuel Macron announced a snap election that ultimately delivered an unworkable hung parliament. The CAC 40 has dropped 3.2% since, while the Stoxx 600 has rallied nearly 6% over the same time. 

Investors have also stripped French equities of their premium valuation relative to Germany’s DAX Index in the past year. The CAC 40 now trades at 14.8 times forward earnings, putting it at a slight discount to the DAX — an unusual occurrence over the past decade. 

Banks, highway operators and energy firms are among the most at risk from continued political upheaval as they tend to get a larger share of revenues domestically. But overall, about 80% of the CAC 40’s sales are generated overseas, according to data from Citi, implying a low earnings risk to behemoths such as LVMH, Sanofi SA and TotalEnergies SE. 

“For me, the French situation isn’t a game changer for the European rally overall,” said David Kruk, head of trading at La Financiere de l’Echiquier. “It might actually encourage some dip buying.” 

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