The world’s eyes will be on the increasingly populist election in the US this fall. As Democratic Presidential Hillary Clinton is currently struggling to recover from phenomena as well as from her “let them eat cake” moment by disparaging Trump voters as a “basket of deplorables.” What is taking place in the US is not a one-off situation, a Morgan Stanley research report notes. Shortly after the US Presidential election, France will hold primaries with full elections in the spring. Much like the US, an increasingly tolerant electoral attitude towards accepting the unknown and voting for radical alternatives could make the outcome increasingly unpredictable. Despite this, Morgan Stanley says the stock market has priced in this disharmony and recommends buying French stocks.

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The terror of the French political elite is an 88-year-old man

The terror of the French establishment is not just a potential disgruntled militant willing to sacrifice their life for a religious cause. The horror of the political elite is the Donald Trump of France, 48-year-old Marine Le Pen, president of the National Front conservative party.

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Marion Maréchal-Le Pen, nièce of Marine Le Pen and highly influential in the FN Photo by Remi Noyon

In some respects, Le Pen is akin to US Presidential candidate Donald Trump. She is a populist who campaigns against globalization, trade agreements and increasing income inequality. While labeled “far-right,” in fact her support “appears to come from dissatisfied former Socialist and Communist party supporters, with many from the working class who feel abandoned by the political Left,” the Morgan Stanley report noted.

If Le Pen wins the presidency, she is likely to find an uncooperative right and left wing in the nation’s National Assembly, which the report considered among the worst case scenarios for the stock market.

In 2012 Le Pen ran for president and only received 17.90% of the vote against eventual winner François Hollande and runner-up Nicolas Sarkozy. This time, however, she is leading in the polls and is considered a legitimate contender.

 

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The popularity of a populist rises as the economy fizzles

Tension is high in advance of the November 20-27 French Republican primary and the ruling Socialists vote on January 22-29. The general election is on April 23-May 7, 2017.

While populist political leaders on a national level have been roundly rejected in the past, this time, in the wake of a Brexit vote, the result could be different for a number of reasons, Economist Carmen Nuzzo along with a team of Morgan Stanley strategists note in the September 12 report.

The report, titled “French Elections: Never Say Never,” notes that the increasingly exasperated electorate could use the polls to express a protest vote against status quo economic and social policies.

In a nation where income inequality and unemployment is rising while the economy remains sluggish, with the German economy pulling down a larger slice of the economic pie since going on the common euro currency. The economy has not always played a major role in French elections, but this year could be different.

To battle a lack of economic competitiveness, the current government of center-left political leader Francois Hollande has enacted a mix of government cuts to social programs, labor market reforms and deregulatory efforts in an effort to remain competitive with Germany.

Government labor cost reductions and tax incentives for first-time hiring have most recently boosted job creation, but employers in France continue to face headwinds from very high firing costs, the report noted. As a result, companies have been hesitant to hire permanent workers, rather turning to part-time contracts for low to middle-income families.

While this tactic provides flexibility to the employer, it is a continued sign that globalization, advocated by both establishment parties, might not be working for large segments of the working-class population.  This adds to the uncertainty and job insecurity. “Disconcertingly, demand for temporary jobs and job vacancies have stopped accelerating in recent months, suggesting that the latest unemployment drop will probably not be sustained.”

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Morgan Stanley: Buy undervalued French stocks

While economic issues are important in this election cycle, the more emotional areas of immigration, crime and terrorism have the common electorate on edge and are also driving Le Pen’s popularity.

If Le Pen wins it could lead to a vote to leave the European Union Brexit-style, but the report considers such an outcome unlikely regardless of the election’s winner. Morgan Stanley, for its part, is not projecting a Le Pen win, but thinks the election could be close.

Despite it all, Morgan Stanley is bullish on French stocks, with the MSCI France now trading at 12 times earnings, and points to relative value trades:

We recommend buying French stocks versus Italy, as French equities tend to outperform when Italian bond spreads widen. Moreover, the relative price underperformance of France in recent months has significantly exceeded its relative EPS underperformance. For bond investors, with QE and in the current low yield environment, OATs should remain well bid versus non-core markets. Furthermore, 10s-30s French-Germany flatteners, which appear cheap, also offer protection should concern about the EMU irrevocability resurface. In this scenario, an otherwise well-supported EUR would come under severe pressure.

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