A Year After Win, Markets Still Fans of Macron. What's Next?

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(Bloomberg) -- When Emmanuel Macron prevailed in the French presidential election last year, global shares rallied and the euro jumped. Now investors need to know where he can go from here.

Macron’s passage of labor reforms and tax cuts within his first year has boosted confidence he will be able to push through more changes in a country known for resisting them -- helping small and mid-cap domestic stocks outperform their European rivals. He’s also been lucky: riding the wave of synchronized global growth, the French economy has picked up.

“After one year, you could say that for once, you’ve got a president who is delivering what he says,” said Sylvain Goyon, an investment strategist at Natixis SA in Paris. “The momentum is key.”

And yet, the challenges are numerous: from a railway strike protesting his plans to eliminate job security for new employees, to Air France workers demanding a pay raise and a European political landscape resistant to further integration. Backing down from the railway measures -- which Macron has said he won’t -- would echo similar defeats of reform efforts in the past, dealing a symbolic blow to his agenda. The good news for him is that, as the strike enters its fourth week, more and more people are turning to buses and ride-sharing apps, limiting the disruption.

A centrist elected on a mandate of reform, Macron has made some initial gains. In moves most pertinent to investors, he scaled back a wealth tax so that it no longer applies to stocks, introduced a flat rate on capital gains tax, cut corporate tax rates and passed some initial labor reforms aimed at making the job market more flexible. At the same time, French economic growth accelerated to the fastest in six years in 2017, and the jobless rate is gradually falling.

Among the long-term winners of these measures are companies with a significant tax base in France as well as labor-intensive industries such as tourism, construction and services. Macron’s plans to transform the tax credit known as CICE into a lasting reduction in employer contributions and cut the corporate tax rate will help boost profit by more than 5 percent for a number of companies including Elis SA, Iliad SA, Nexity SA, Eiffage SA, and Aeroports de Paris, Natixis strategists said in a note last August.

The fiscal measures have been underestimated, according to BNP Paribas SA. “When companies actually see better reported earnings, then we will expect more investors to start pricing in upside coming from French tax reforms” over the next 18 months, said Ankit Gheedia, an equity strategist at the bank.

Here’s what they are looking for in terms of further reforms in the president’s five-year term:

Labor:

The second wave of measures is expected to cut employment levies, improve job training and tighten links between job-seeking and jobless benefits. A bill dubbed PACTE will further deregulate labor and funding rules for companies with the goal of helping them grow and create jobs, while also offering increased profit-sharing for employees. This could help local labor-intensive industries, such as food, retail, services and manufacturing.

At the same time, brewing unrest is also a risk to the country. Strikes demanding better pay increases have cost the Air France-KLM Group 220 million euros, the chief executive officer said on Friday, with the stock falling more than 10 percent over the past month. If the protests spread to other sectors, the country could end up in a gridlock, which might prompt the government to backtrack on some of the reforms.

Budget and pension:

While a strong economy flattered France’s budget last year, its structural budget deficit is not yet on track to narrow, with Macron’s latest budget putting off spending cuts. This could dent investor confidence in the country, limiting investment flows. Macron in his campaign also proposed harmonizing private- and public-sector pensions in order to control state costs.

Europe:

Macron’s election marked the defeat of anti-euro Marine Le Pen, setting the stage for the sovereign spreads of countries such as Italy and Spain to narrow and the euro to appreciate as regional growth quickened. Of course, European unity also depends on the politics of other countries, but progress on his proposals for deeper ties would be another boost for European assets.

Reduced risks of a disintegration of the single-currency bloc could be particularly reassuring for the region’s banks, which hold large amounts of euro-denominated debt. Member countries are deliberating setting up a common deposit insurance scheme and strengthening the euro-area bailout fund.

“What I think is missing for now is really delivering on the European agenda,” said Maxime Alimi, head of investment strategy at AXA IM in Paris. “If investors start to really see potential for further political integration in Europe, then there could be a further reduction in the risk premium again on European assets.”

©2018 Bloomberg L.P.

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