Deutsche: "Euro Stocks Haven't Priced In Any Adverse French Outcome", That's A Mistake

Tyler Durden's picture

Ahead of the first round of the French elections on Sunday, Deutsche Bank's equity strategist Sebastian Raedler again reminds his bank's clients and the seemingly unperturbed markets, that despite the  tightening of the poll numbers among the four front-runners, European equities show little sign of pricing in a meaningful political risk premium. In fact, as he notes below, European equities appear to not have priced in even a modest political risk discount.

This may be a mistake. As a reminder, if we look at the last 3 polls run by those pollsters then the spread between the four candidates is at an average of 4.5%. Macron’s average is 23.3%, Le Pen 22.3%, Fillon 19.7% and Melenchon 18.8%. So it’s quite possible that these 4 candidates will be clustered together given that the spread is within the margin of error from previous elections (see "Is A Le Pen - Melenchon Second Round Possible: A Concerned Deutsche Bank Answers").

Meanwhile, as equities fell 8% ahead the UK referendum last June and 4% ahead of the US elections in November, they have remained close to their recent highs this time around – and now trade around 3% above the fair-value levels suggested by DB models. European banks have also held up well despite falling bond yields, with their price relative around 5% above the level implied by the German 10-year yield.

Raedler further notes that Deutsche Bank expects only moderate upside for  European equities in case of a Macron/Fillon victory in the second round on May 7th (~3%), moderate downside in case of a Mélenchon win (~3%) and significant downside in case of a Le Pen victory (~15%).

So what to expect on Sunday?

According to DB, polls ahead of the first round of the French presidential election on Sunday show the four front runners within five percentage points of one another, with Macron at 24%, Le Pen at 22% and Fillon and Mélenchon at 19% each.

Our rates strategists highlight that the average polling error for the first round of past French elections has been six percentage points, suggesting that the scope for a surprise relative to the consensus expectation of a Macron / Le Pen run-off remains high. Polls suggest that Macron would beat Fillon, Le Pen and Mélenchon in the second round, while Mélenchon would beat Fillon and Le Pen, and Fillon would beat Le Pen – all by a margin comfortably above the historical maximum second-round polling error of 10 percentage points.

That much is known, but what is priced in? It appears that when it comes to stocks at least, the answer is nothing but blue skies.

As Raedler puts it, European equities are not priced for a political risk discount: despite the closeness of the first-round polls, "there is no obvious political risk discount priced into the European equity market."

At 14.9x, it is trading around 2% above the current fair-value implied by our P/E model (14.6x) and around 3% above the level implied by our short-term Stoxx 600 fair-value model (378 versus 365). This suggests European equities are still priced for a slight valuation premium on the back of the recent sharp acceleration in global growth momentum, rather than a political risk discount.


While increased political risk led European equities to correct by 8% ahead of the UK referendum in June last year and by 4% ahead of the US presidential election in November, we have not seen a similar pull-back this time around, with the market trading close to its 2017 peak. We expect moderate upside for European equities in case of a Macron or Fillon win in the second round of voting on May 7th (~3%), moderate downside in case of a Mélenchon win (~-3%) and significant downside in case of a Le Pen win (~-15%). This implies mild upside for European equities if the first-round vote results in a Macron / Fillon run-off, more meaningful downside in case of a Le Pen / Mélenchon run-off and less clear directionality for all other scenarios.

How about European banks. Here equities are likewise holding up well despite the recent fall in bond yields:

European banks’ relative prices have moved closely in line with German 10-year bond yields over the past two years – but are now around 5% above the level suggested by bond yields after their recent fall to 0.2%. Our fixed-income strategists expect German 10-year bond yields to rise to around 0.5% in case of a Macron or Fillon win, to fall to 0.1% in case of a Mélenchon win and to fall to -0.1% in case of a Le Pen win.

For DB, this would imply 5% outperformance for banks in the Macron / Fillon scenario, 8% underperformance in the Mélenchon scenario and 14% underperformance in the Le Pen scenario .

Finally what about French domestic cyclicals? Here DB expects a play on reduced political risk.

French stocks with high domestic sales exposure and a negative correlation with peripheral bond spreads (most of them financials) have underperformed defensive French exporters by around 10% since the beginning of the year, a worse performance than would have been suggested by the historical relationship with bond yields. If the political risk scenario in France is avoided, we would expect this trade to re-connect with bond yields (pointing to 10% relative upside). Similarly, French financials have underperformed German financials by more than implied by the relationship with bond yields, a trade that is also likely to reverse in a benign election scenario

All of the above in charts:

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Philo Beddoe's picture

WTF? Fucling retards. The markets rallied after Brexit and Orange Jesus.  You could put Attila the Hun in charge of a one world government and the market would rally. 

adr's picture

If Hitler came back and was put in charge, would markets still rally? 

Depends on whether or not algos were programmed with a Hitler sell signal. If not, markets still go up. 


BetaGap's picture

What if he is back but in a third world country like Turkey?

Making Merica Great Again's picture

Hitler looks cute after i saw what Turkey has.

HRClinton's picture

It's all because the algos are not blinded by hopes, dreams and wishes that the masses have.

No emotional bias for them. The algos know that it matters not who is elected.

mily's picture

Because there is no adverse outcome £200bln "liquidity" a month would not heal

Dr. Engali's picture

Meh, no matter the outcome the game will go on. BTFD.


I have no doubt the market tanks if Trump wins.

~Mark Cuban, Expert

adr's picture

Markets haven't priced in anything other than central banks buying more assets. 

This is a huge mistake but nobody cares because stock markets around the world keep going up. 

HRClinton's picture

Smart money does not pee into the wind.

Only habitual contrarians do.

buzzsaw99's picture

they don't need france, they have draghi.

Ghordius's picture

those who profit from volatility pray for volatility and speak on behalf of volatility

be kind to the middleman, sell, buy, sell more, buy more

in both cases, the Far Leftist or the Far Rightist... it's the president, not the parliament that is being elected

and neither France's place in the EU nor in the EUR can be changed by the president alone. he or she needs... parliament for that

buzzsaw99's picture

omg best comment of yours i have ever read. kudos.

HRClinton's picture

Yes, Parliament and the Ruling Elite of the influential, rich and powerful is the Steady Hand at the Rudder.

Even monarchs had their limits - especially if they tried to go against the interest of these people.

This is just a current manifestation of a timeless process. Which is why Bill and I don't drink the Kool-aid that we sell. That stuff will make you sick or kill you.

Ghordius's picture

yes, I like a Steady Hand At The Rudder

no, I do not see the reason for swerving hard to the Right, and then hard to the Left, and back and forth

yes, monarchs had limits, most of the time. no, I see that that as a Rule of Many instead of a Rule of One

yes, the State ought to Serve The People, not Lead The People

no, I see all that as the steady hand of moderation, not of the "influential, rich and powerful". that would be the Rule of the Few

the difference is in plenty of political parties versus two versus one party only

the difference is between political parties that can die... and those that are immortal

Hongcha's picture

SCGLY continues to price in a globalist victory in France.

Librarian's picture

Plan B's apparently are highly overrated.

It seems like just a few hours ago that the Brexit remainers accused the leavers of "having no plan".

Political history is rife with politicians with "secret plans". (Is today's Tyler article just a recook of this lukewarm leftover?)

Sometimes politicians are even imputed with nefarious "secret plans" if the other side has no other stone to lob. (This is a good example of 1968 Fake News that we didn't even think about at the time)


My secret plan is to get to lunch early today and finish up right after lunch.  As my British colleagues would say -- today is POET day.