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Is Le Pen mightier than Le Market

Brian Nick, Chief Investment Strategist, TIAA Investments


February 24, 2017

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Quote of the week

“Do you hear the people sing? Singing a song of angry men.” – Les Misérables

The Lead Story: “Nous sommes inquiet,” says France’s bond market

Can anyone blame holders of French government debt for being a bit worried? Populist candidate Marine Le Pen, who has pledged to abandon the euro and call for a referendum to leave the European Union if elected president, has been gaining in the polls. Her odds of winning have risen from 25% in mid-January to just under 35% this past week. Moreover, her support has been steadier that that of center-right Republican Francois Fillon and independent centrist Emmanuel Macron.  

Brian Nick, Chief Investment Strategist, TIAA Investments

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Article Highlights

While Le Pen remains unlikely to win the presidency, recent history tells us that a lot can happen between now and April 23, when voters cast their ballots. (If no candidate gains a majority, as seems likely, the top two candidates meet in a May 7 runoff.) Nonetheless, the increased political risk associated with a Le Pen victory has spooked France’s government bond market. During the week, investors sold 10-year French debt in favor of similar-maturity German debt (considered a safe haven), expanding the yield gap between the two to 79 basis points (0.79%) on February 21, the widest closing spread since November 2012.  Six months ago, the difference was roughly 20 basis points (0.20%). 

In contrast, France’s stock markets have not exhibited the same degree of volatility. This is partly because French shares are more likely to be owned by domestic investors, who are less swayed by political uncertainty. But it’s also likely that recent improvements in sentiment data is supporting their steadfastness: business and consumer confidence are both sitting at multi-year highs. (See “Below the fold” for more on French and Eurozone economic data.) Europe’s broad STOXX 600 Index also remained calm, declining just 0.1% for the week (in local currency terms).

Meanwhile, emerging-market (EM) equities remained star performers. The MSCI EM index is up 7.24% and 10.54% (in local currency and U.S. dollar terms, respectively) for the year to date through February 23. Gains have been fueled by a bounceback in EM currencies amid a commodities rally and signs of improving global growth.

In other news: U.S. stocks rise for the fifth consecutive week

After beginning the holiday-shortened week with a fresh record high, the S&P 500 Index meandered a bit but still posted a solid gain for the week.

With broad market volatility so low—it’s been nearly three months since the S&P 500 has gained or lost 1% in a single day—dispersion among individual U.S. equity sectors has also fallen. Growth stocks have made a comeback, led by Technology and Consumer Discretionary shares. Energy stocks have brought up the rear, hurt by a 30% fall in natural gas prices.

These three sectors are among our most preferred for the balance of 2017. We believe Energy company earnings could provide upside surprises should EM economies continue to demonstrate signs of strength. Tech and Discretionary are also well positioned to benefit from the uptick in global growth. They could potentially fall prey to trade protectionism, however, given the global business models of tech hardware and retail companies.

In U.S. fixed-income markets, the lack of specifics related to President Trump’s policy proposals, along with the uncertainty over several high-stakes elections in Europe (add the Netherlands and Germany to the mix), boosted demand for safe-haven assets like U.S. Treasuries. The yield on the bellwether 10-year note, which began the week at 2.42%, closed at 2.32% on February 24. (Yield and price move in opposite directions.)

Current updates to the week’s market results are available here

Below the fold: Europe delivers a healthy dose of positive economic news

Over the past six months or so, Eurozone data has topped expectations more often and by a greater amount than in the U.S. This past week, the Citi Eurozone Surprise Index surged. This index gauges the extent to which economic data releases diverge from consensus forecasts; rising index levels indicate more upside surprises. 

Among the other encouraging data releases:

In the U.S., minutes from the Fed’s January meeting, released on February 22, conveyed that officials could begin to raise short-term interest rates “fairly soon.” Does that mean the Fed will act in March? Markets still see that as less than a 50-50 proposition, as do we.

It was a light week for U.S. data reports:

Back page: One prediction that, happily, did not pan out

Last January, global equity markets plunged amid a steep drop in the value of China’s currency, the yuan. Investors interpreted that fall as evidence of a worsening slowdown in the world’s second-largest economy—with potentially negative consequences for global growth.

During the selloff, headlines trumpeted forecasts that predicted a “cataclysmic year” marked by “global recession and deflation.” The recommendation from many analysts was simple: sell everything except high-quality bonds. 

Looking back, we know how that advice panned out. 

Sure, hindsight is 20/20. But we have long maintained that such an “all or nothing” strategy, while offering surface appeal during periods of unsettling volatility in equity markets, has generally led to undesirable results. Not only is correctly predicting market tops and bottoms very difficult, but extreme asset-price movements have often presented attractive buying opportunities.

Heading into what may well be a challenging stretch, investors should continue to be well-served by remaining diversified, sticking to their investment plan, and taking a long-term view.