Following the weakness in the few minutes of after-hours trading on Friday's US session that overlapped with the first headlines from France, we are getting a first glimpse at the posible fallout from the Paris terror attacks. The Middle Eastern stock markets tumbled significantly with Saudi Arabia's Tadawul All Share index down 3% (biggest drop in 3 months) to its lowest since December 2012, and Dubai's FMG Index plunged 3.7% to its lowest since 2014. Short-run implication for the equity market is likely to be negative according to Goldman, with a notably higher risk premium regarding uncertainties about the medium-term political implications.
Friday's after-hours action in US equity futures was weak - and this was hours before the worst headlines hit:
And Middle Eastern markets are giving us a glimpse of what is to come...
To 3 year lows...
Near 2-year lows...
As Goldman Sachs warns, Attacks in Paris: Increased uncertainty likely to weigh on activity and increase market volatility in the short run
French President Francois Hollande has declared a 'state of emergency' following six simultaneous terrorist attacks in Paris on Friday night (November 13, 2015), for which the Islamist State (IS) organisation has claimed responsibility.
The 'state of emergency' entails the imposition of the following measures until further notice:
- Reinforced controls at French borders and for all transport to and from other countries.
- A reinforced military presence in Paris, with the possibility that curfews may be introduced.
- Public events (sport, cultural and entertainment) may be cancelled when public security is believed to be at risk.
- Additional security and police controls (including the ability to conduct home searches at any time without warning).
- Political tensions intensifying, leading to heightened political uncertainty
Political reactions –On Saturday morning, President Hollande declared three national ‘days of mourning’ for the victims of the terrorist attacks, insisting on the need for national unity and solidarity. His immediate response reflects the French authorities’ fear of growing division and tension within the French population, which Friday’s events are only likely to intensify. President Hollande also expressed France’s determination to continue to fight terrorism both inside and outside its borders.
The President’s communique was followed by statements from other political leaders, including former President Nicolas Sarkozy (now head of the centre-right Les Républicains party) and Marine Le Pen (leader of the far-right-wing Front National). Mr. Sarkozy called for a “drastic reinforcement” of security measures, while Ms. Le Pen stressed that “France and French citizens are no longer safe”.
Meeting the challenges posed by these attacks represents a significant political test for the French government in general, and for President Hollande (as Head of State) in particular.
Political tensions are likely to increase ahead of France’s regional elections, scheduled for early December (6 and 13). As already reflected in yesterday’s reactions from Mr. Sarkozy and Ms. Le Pen, issues of security will inevitably come to centre-stage in the electoral debate. Heightened concerns about security and immigration are likely to bolster the performance of Ms. Le Pen’s Front National (which has taken a hard line on these issues), while simultaneously forcing the mainstream parties to clarify their position on both issues.
Under such electoral pressures, the French government is likely to adopt a harder line towards immigration, complicating management of the ongoing European refugee crisis and creating further political tensions at the EU level at a sensitive time.
In the longer run and ahead of the Presidential election in May 2017, the Front National will likely benefit from ongoing concerns about security and migration, in particular at the local level. Whether this proves sufficient to sway the dynamics of the presidential election will depend on the ability of mainstream parties to tackle terrorist risks credibly and effectively in the coming months.
Rising uncertainty will weigh on economic activity in some sectors, but largely in a transitory manner
Concerning the economic impact of the terrorist attacks, the immediate impact is likely to be a decline in tourism (to Paris in the first place) and an associated fall in (non-durable) consumption (as spending on entertainment/sport/cultural events declines). Activity in the retail sector will be negatively affected in the short run. Consumer spending is likely to remain weak for some months if concerns about further terrorist attacks persist, as some security experts say is likely. At the same time, there is likely to be some substitution of spending towards ‘home-based’ entertainment and leisure.
Taking a longer perspective, the duration of the ‘confidence shock’ stemming from the terrorist attacks (reflecting concerns about security) is uncertain.* While heightened security concerns and uncertainty persist, investment decisions and purchases of consumer durables are likely to be delayed. But such effects can reverse quickly should confidence be re-established. Whether we see a further escalation of events – more terrorist attacks and/or an intensified military response aimed at IS – remains key in this respect.
Where we can be more certain is that the French government budget will become more stimulative, as additional security and military expenditure to address the terrorist challenge is announced (as was already the case in the 2016 budget) (see here).
In sum, the overall economic impact of the terrorist attacks will be negative in the short run, and focused on specific sectors. At longer horizons, the magnitude of the impact is unclear. Higher government spending will support aggregate demand as security measures are expanded. The response of the private sector will depend crucially on whether (and how quickly) confidence can be restored and uncertainty reduced.
We expect the likely negative market impact to be short-lived
In the similar attacks in Madrid (March 11, 2004) and London (July 7, 2005), the impact on country-wide statistics and overall consumer confidence was relatively small. Consistently, knee-jerk flight-to-quality financial markets, and the increase in volatility, proved short-lived. As said above, it is likely that the near-term negative implications for some categories of household spending (culture and leisure services offered outside the home) will be compensated by shifts in consumption patterns and the boost to aggregate demand from government spending.
Beyond the increase in near-term uncertainty, asset performance will be primarily driven by expectations around the medium-term economic outlook. At this early stage, changes to our forecasts for Euro area sovereign bonds (which we expect to offer better returns than their US counterparts thanks to the ECB’s upcoming easing) and the Euro (which we expect to weaken, reaching parity against the USD by the end of this year) do not seem warranted.
Short-run implication for the equity market is likely to be negative …
As far as the equity market is concerned, the short-run implication is likely to be negative. Equities markets remain volatile and fragile given existing macro uncertainties surrounding US interest rates and emerging market (EM) growth, together with mixed results from the corporate sector.
… with a notably higher risk premium regarding uncertainties about the medium-term political implications
Recent events in Paris are likely to push the equity risk premium (ERP) higher in the short term, reflecting both the uncertainty about the immediate responses but also the medium-term political implications. European countries are already struggling to deal with the refugee crisis and to agree a coordinated response. This event will likely strengthen the hands of nationalist parties both in France and elsewhere. With a number of important elections coming up in Europe over the next year, this will increase the uncertainties around the likely results, including that of the UK referendum.
Up until now, the bright spot for the equity market has been the resilience of domestic demand and we have strongly favoured domestic-facing companies.
There may be some immediate (but transitory) weakness in discretionary consumer spending, or a hit to consumer confidence, which may temporarily hit the CAC 40 as it has a high exposure to the retail sector. Indeed, the CAC 40 has a high weight in consumer stocks and may be more affected because of the impact on domestic consumer confidence in France. That said, equally, these names are often seen as safer than higher-beta industrial stocks, especially if the impact of the events in Paris is to raise the overall risk premium on equities. Therefore, we continue to believe that consumer stocks are likely to remain more resilient across Europe over the next several months, while we remain negative on industrial capex exposed areas of the market that are suffering from the twin effect of commodity capex cuts and slower EM industrial demand. Our 3-month target remains unchanged for the SXXP and SX5E at 365 and 3300, respectively, which implies a modest decline of 1% in the SXXP and 2% in the SX5E.
All in all, we do not expect a sustained increase in French sovereign risk.
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And here are the other major banks:
Credit Suisse (Oliver Adler, Joe Prendergast)
- Past experiences with terrorist strikes in EU suggest that financial mkt impact of even the most severe attacks tends to be short-lived
- Impact on markets will probably remain limited; EU policy makers, esp. ECB, may provide some added, at least verbal, support to economy and mkts if economic risks are deemed to have increased
- A negative impact on EUR is likely and could be more sustained
- EUR may be boosted initially as a drop in European equity markets is met by a currency hedging response; but overall economic, policy and flow implications appear EUR negative
- CHF may experience some further increase in inflows, as the case for further ECB easing if anything intensifies; SNB may then respond with its own easing measures
Credit Agricole (Manuel Oliveri)
- Paris attacks may dent investor appetite for risk assets, even though they are unlikely to have any lasting impact from a broader angle
- Investors may opt for CHF at least in short term; buying interest for JPY probably muted given BOJ meeting, where there is always the risk that they do more
BofAML (Athanasios Vamvakidis)
- Impact from Paris attacks for markets should be negative in short term, consistent with what was seen during previous terrorist attacks of such magnitude; impact will also depend on how the West will react in days ahead
- Doesn’t expect Fed to change its paths of monetary policy, unless situation escalates further
BBVA (Roberto Cobo Garcia)
- A prolonged global spike in risk aversion seems unlikely
- Risk assets will probably continue generalized correction observed last wk
- Doesn’t expect decision-making process of Fed to be influenced by attacks; Fed mainly focused on domestic economy and given positive evolution of U.S. macro context and the ongoing reduction of slack in U.S. labor mkt, still expect the Fed to hike rates in Dec.
Eurasia (Mujtaba Rahman)
- Paris terrorist attacks highlight security as another source of European vulnerability, alongside economic weakness and seriously divided and fragmented politics
- These events raise additional concerns for investors to focus on
- Attacks will exacerbate all of challenges Europe is currently facing; may make an agreement over refugees even more difficult to achieve
- Attacks will undermine French govt’s ability to focus attention on improving economy; may raise questions over its competence while Hollande’s military campaign in Syria likely to continue; U.K. intervention in Syria becomes more likely