Morgan Stanley Says Buy French Stocks, Election Risk to Fade

(Bloomberg) -- Investors should buy French stocks before Sunday’s second round of the snap parliamentary elections because the market is likely to rebound in either of the two most probable outcomes, according to Morgan Stanley strategists.

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The yield premium on French bonds over German securities already has narrowed from its peak after the election was called, Morgan Stanley strategists Marina Zavolock and Regiane Yamanari wrote in a report Thursday. Stock investors should now follow their lead and add exposure to the country, they said.

President Emmanuel Macron’s centrist group and a left-wing alliance opposed to Le Pen strategically pulled 223 candidates out of constituencies in an effort to avoid splitting opposition to the far right and lessen its chances of winning enough seats to form a government. No party is likely to win the 289 seats needed for a majority, a Morgan Stanley poll of investors showed.

“We believe the two key remaining French election scenarios – no majority and RN absolute majority – would both ultimately be followed by a recovery in French and wider-European equities indices,” they wrote.

Zavolock and Yamanari advised buying European defense stocks, Italian banks, French lender BNP Paribas SA, French building-materials company Saint-Gobain SA and utility Veolia Environnement SA.

The CAC 40 Index rose 0.8% to 7,690.31 at 1:09 p.m. in Paris, outperforming the 0.6% gain in the Stoxx Europe 600 Index.

The French benchmark has declined 3.9% since Macron shocked investors by calling the snap election on June 9, while the euro has weakened versus the dollar and the yield premium of French bonds over German securities has widened. The equities selloff wiped more than €200 billion off the value of French stocks.

The yield on French OAT bonds peaked at about 85 basis points more than bunds after the election was called on concern that France’s public finances would worsen. It has since retreated to about 65 basis points and could compress further, to about 60 basis points, after Sunday, Morgan Stanley’s Lorenzo Testa wrote. The euro is likely to have a brief rally of about 1%, the firm’s Wanting Low said in the same note.

According to the Morgan Stanley investor poll, a victory by the left-wing New Popular Front would have shown the greatest skew to investors potentially cutting their exposure to European assets, the firm said. If the National Rally wins, its economic policy agenda may be more moderate than it has been in the past, Morgan Stanley said.

For some investors, the level of uncertainty is just to high to make a move before the polls give their verdict. Gilles Guibout, a fund manager at Axa Investment Managers who trimmed his exposure to French banking stocks after the elections were announced, said he’s not taking the risk.

“I don’t gamble with my clients’ money and there just isn’t enough visibility on the political situation to make a move,” he said.

(Updates to add investor comment in 10th-11th paragraph.)

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