A potential economic and political revolution in France and Europe was averted. President Emmanuel Macron won a decisive victory over the populist Eurosceptic Marine Le Pen in the second round of the French elections on April 24. The results should allay immediate concerns about potential cracks in NATO and the European Union’s (EU’s) efforts to forge closer ties to respond to Russia’s devastating war in Ukraine. We also expect the market-friendly Macron to address high inflation in the cost of living stemming from higher energy and food prices, which should be positive for the region’s second-largest economy and broader regional equity markets.
Confronting a Cost-of-Living Crisis
Macron faces some significant economic challenges at the outset of his second term. The war in Ukraine has pushed already-high European energy prices even higher. Europe imports about 40% of its natural gas and almost 30% of its crude oil from Russia, according to data from regional statistics compiler Eurostat.1 Fears about the region’s lack of energy independence and potential supply interruptions have made regional energy more expensive over the past two months.
Given how important oil is to the global economy, rising prices could hurt economic output. Europe has been racing to find new supplies from the United States and Qatar to reduce its dependence on Russia. Some countries, like Germany, have been reluctant to immediately curtail Russian gas imports, while others are targeting the end of 2022 to stop using Russian energy.
Food prices, which started to rise last year, are of increasing concern in the region. Russia is a major exporter of fertilizer, a key input in crop production, and both Russia and Ukraine are significant wheat exporters. Supply disruptions resulting from the war are pushing up grain and other food prices.
European consumers have felt the pinch. As inflation stays higher for longer and trade remains disrupted, we could see greater demand destruction and a weakening of the European economy in 2022. In response to these pressures, we expect Macron’s budget to focus on supporting workers and insulating households from higher prices and a potentially shakier economy.
Another risk is the political ramifications of a weakening economy and higher prices. The French presidential election, which saw the defeat of the populist candidate, was not a complete mandate for Macron as Le Pen improved on her share of the vote from five years earlier and the more far-left and far-right parties did surprisingly well in the first round of voting. These gains are further underscored by rising support for populist parties from Spain to Hungary as economic anxiety increases. Macron’s next political test will be in the June legislative elections.
Focusing on the Future
In addition to tackling higher prices, we expect Macron to spearhead other potentially beneficial initiatives. The first is to push further labor market reforms and propose changes to the country’s unemployment insurance scheme. The new government will also need to come to a consensus on pension reform though we expect any changes, such as raising the retirement age from 62 to 65 years old, to be incremental.
Macron is also likely to focus on cutting corporate taxes and investing in key sectors for the future to boost long-term economic growth. Many of these investments have a “green” tilt to them, such as renovating 700,000 homes per year to cut energy consumption.
Some of the green efforts are part of broader EU strategy to focus on improving energy supply resilience, particularly given the challenges the region faces weaning itself off Russian natural gas. Europe’s move toward greater renewable energy generation was well underway prior to the Ukraine crisis, and the need for such a program has become more pressing since the war began. We believe the region will need to continue to invest in local renewable energy as well as balance responsible climate stewardship against responsible energy security.
On the Corporate Margin
Business-friendly French policies may help mitigate some of the impact on corporate margins from higher energy, supply chain and logistics costs stemming from the war and the lingering effects of the pandemic. Initially, the question for companies was whether they had sufficient pricing power to pass along these costs. Now, however, there is a balancing act. Cost increases are so substantial that companies must weigh raising prices against the possibility they will hurt demand if they go too far. At the same time, they must consider the likelihood that they will hurt profits if they do not, or cannot, fully pass along higher costs.
Meanwhile, attempts to bring manufacturing closer to home and fortify supply chains that began during the pandemic should pick up pace over the coming years. Investing in greater supply chain flexibility involves reassessing the risks of locating factories in distant and undemocratic states. Firms also are evaluating resiliency beyond just their immediate suppliers; they are now considering the resiliency of the suppliers to their suppliers. As a result, we would expect to see companies build facilities closer to home and in places where potential political risks are lower, a potential boon to automation companies that help with reshoring.
Uncertainty from the grinding war in Ukraine and rising inflationary pressures are likely to endure for the near future. Eventually, we expect to see a Europe that is more united and economically and ecologically sustainable, and better able to withstand external shocks. Given France’s importance within the EU, we believe Macron’s re-election reinforces this positive outlook. We believe investors should benefit from a stronger Europe, and that the recent market volatility has only increased the potential to uncover heavily discounted long-term value opportunities.
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