UBS: France - risk scenarios around election and beyond

French Equities too relaxed – CAC 40 gap to OAT spread widest since 2012

This country note on France focuses on the presidential elections of 23 April and 7 May, which are a key concern among investors and are driving a potential dislocation in markets. France rode the cyclical rally in H2-16 and turned a blind eye to the jump in the OAT spread. France normally trades at a 10% P/B discount to Europe; today, it is a mere 15%, while the periphery trades on above-average discounts of closer to 40%. Today vs July 2012 valuations point to potential downside of c.20-25% on a tailrisk outcome. If instead, it's Relief & Reform, we see a turning point for Europe's swing investor. This could close the record $253bn ETF flow gap between the US and Europe.

Downside (Eurozone break-up fears), upside (reforms and a growth revival)

Opinion polls suggest that the Eurosceptic Front National under Marine Le Pen will make it into the second round of the presidential election, but will then be defeated by either Emanuel Macron or François Fillon from the centre right. If the polls are wrong, a Le Pen victory would likely raise investor fears given her proposal to reintroduce a national currency and to hold a referendum on EU membership. There are several legal hurdles to implementing such an undertaking and the cooperation of parliament would be essential, but, faced with uncertainty and downside risks, Eurozone break-up fears could re-emerge. By contrast, both Macron and Fillon promise substantial reforms, including more labour-market flexibility, raising the retirement age and public-spending cuts. Given France's favourable demographic outlook, productivity-enhancing structural reforms would likely imply an improved longer-run growth outlook.

How to invest in a Tail-Risk Scenario?

Quality loves a crisis and has lagged BUY 'havens' that rise 'with' spreads: Switzerland – Pharma now trades on a cyclical PE. Consider: Danone, L'Oreal, Essilor, Remy and BIC. SELL sectors that fall when spreads rise, with domestic exposure and debt, such as Financials, Retail and Utilities. Consider 14 stocks, such as: Soc Gen, BNP Paribas and St Gobain, and the most indebted.

Political Relief Scenario? Europe vs US, Periphery, Value & Domestic Beta

While the overall upside might be more modest than the potential downside (above), it could re-kindle the risk-on trade as political risk fades. Reform should support French vs Germany: GDP/profits have lagged since 07 (20% gap). On potential labour reform: we highlight companies with higher wage costs in France.

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