Frexit: What should you expect for European equities? – Goldman Sachs

According to the analysts at Goldman Sachs, in recent weeks, the 2017 French presidential election has been at the forefront of European political risks and lists down the potential impact on European equities of a Le Pen victory.

Key Quotes

“Market participants have focused on rising support for populist Front National (FN) candidate Marine Le Pen and associated ‘redenomination risk’.”

“Although our economists believe that Ms. Le Pen is unlikely to win the election, they estimate that she has the potential to outperform current opinion polls in the first round. We consider the potential impact on European equities of a Le Pen victory using the framework provided by our economists. We would expect:

• A steep rise in the equity risk premium (ERP) to levels last seen during then Euro area crisis (i.e., to 8%-9% vs. 7.5% currently), implying a downside move of 13% to 21% for European equities.
• A significant widening of sovereign spreads.
• A large sell-off in European risk assets. We would expect the clear relative winners to be the DAX, SMI and FTSE 100. The last two are defensive indices and, moreover, are not in the Euro area. The DAX would benefit as investors turn to German assets given increased re-denomination risk in the Euro area. We would expect Euro area Banks (SX7E), the FTSE MIB and CAC 40 to be worst hit, followed by the IBEX.
• We would expect Country selection to become more important than Sector selection, as was the case before the introduction of the single currency and during a brief episode of the Euro area sovereign debt crisis.”

“In the event Ms. Le Pen is not elected (our central scenario), we would expect Bund yields to rise, recoupling with the US, and European sovereign spreads to tighten modestly. We would expect Euro area risk assets such as Banks and the FTSE MIB to enjoy a small relief rally; we continue to recommend an OW on Banks (SX7P). We see a potential for Europe to outperform the US, although European political uncertainty is likely to remain elevated.”