NN IP: En avant, marche!

Financial markets have every reason to be pleased with the outcome of the first round of the French presidential election. The base case of a run-off between Macron and Le Pen has been confirmed and was predicted by the polls. This clearly increases the confidence we have in the polls, which was scattered after the surprising Brexit and US election outcome. In the second round, Macron has a big margin in his favour in the polls and hence he is the most likely candidate to become the next President. An additional point of comfort is that he already came out ahead of Le Pen in the first round and that the losing mainstream parties (le Parti Socialiste and Les Républicains) have advised to vote for Macron.

The initial market reaction was as expected. The flight-to-safety trades and hedges were reversed, leading to a sharp tightening of the France-German yield spread. European equities rose sharply at the opening, with financials and French equities in the driver seat. Having said this, we do not expect a long-lasting election impact. First, because of the fact that the outcome was in line with expectations, and second because of the observation that French equities did not underperform massively German equities, despite a less favourable sector composition (the CAC 40 has more Energy and less Materials and Technology relative to the DAX 30). A third point is the high likelihood of "cohabitation" after the Parliamentary elections in June, which may dilute Macron's program.

Focus back on economic and corporate fundamentals

Now, with the French election bomb largely being defused, investors should refocus on the economic and corporate fundamentals and leave the political analysis – and without any doubt interesting conclusions of what has happened in France – to the political experts. Global earnings momentum remains strong and is positive across all regions. Global equities have followed the trend.

The corporate earnings season witnessed a good start. 75% of companies beat expectations (and these were hardly lowered beforehand!) and the average surprise was 5.3%. Also sales were better than expected and beat by 0.8%. The absolute growth figures are +4.7% for sales and 13.4% for earnings. For the whole of 2017, consensus expects a rise of 11.9% driven by Energy, Materials, Financials and the Technology sector. Also in the Eurozone and Japan, earnings estimates are at double-digit levels.

Macro data continue to point towards an improving economy, even if the surprise indicators have weakened over the past month. Consumer confidence in both the Eurozone and the US is at multi-year highs, unemployment is declining and corporate confidence is strong. The German IFO index is at its highest level in almost six years and the US ISM manufacturing index at a comfortable 57 points. It is our base case that the consumer will start to contribute more to growth over the coming quarters.

Oil price and bond yields are the dominant sector drivers

These data are generally positive for the cyclical sectors relative to defensive sectors. We should however introduce more discrimination amongst sectors as drivers are very different, even within each subgroup. This can best be illustrated by Figure 2 where we have regrouped sectors.

Two drivers pop up: oil prices and bond yields. The decline in both has led to significant underperformance year-to-date of the commodity cyclicals and financials. Winners in this environment were the end-user cyclicals and the sectors that are negatively correlated with bond yields (utilities and real estate).

Going forward, we believe that the drop in bond yields may reverse, given a lower political risk premium and strong macro data. This pleads towards outperformance of financials relative to utilities and real estate. The stronger data point towards a preference for the end-user cyclicals (Consumer Discretionary, Industrials, IT) versus the non-cyclical consumer sectors (Health Care, Utilities and Telecom). For commodity sectors, the visibility on the oil price is low and upside potential looks capped by US oil production rising again. Hence, a more neutral stance seems warranted.