It's three months before the final round of France's presidential election and while polls suggest a comfortable eventual defeat for Marine Le Pen, investors are understandably wary. The political shocks of 2016 are still sending tremors through the investment landscape and while a Marine Le Pen victory, and subsequent possibility of a referendum on EU membership, seem unlikely - it cannot be regarded as impossible. Even the tiny potential for what would surely result in social, economic and therefore capital markets bedlam to rival the horrors of 2007/08 is surely worth factoring into our asset allocation?
Such unknowns are part of the reason that we continue to recommend holding a diversified allocation to both cash and government debt in all portfolios in spite of our continuing belief that equities currently represent the more profitable bet. That government debt allocation tends to be hedged back into the investor's domestic currency within portfolios, a policy that euro-based investors may want to rethink if the odds of break up increase materially of course. Even so, unhedged German government debt seems to be the most popular defence against the potential for a euro break up, with the returning deutschemark thought likely to eventually provide a very strong tailwind to investor returns in the asset class when and if redenomination does occur.
However, nearer term, the more nimble investor could also think about trying to profit from a likely strong ECB response to any widening of spreads to peripheral debt, remembering that the disintegration of the euro would be a process that would take years not months and would not go unchallenged by the powers that be. Exposure to carefully evaluated peripheral European debt has the added advantage of trading pro-cyclically, which may help shield returns if the worst case doesn't materialise and growth and inflation prospects in the region continue to solidify.
So far these remain considerations rather than recommendations. We still believe very firmly that the weight of history and the lack of credible alternatives will keep the euro project more or less intact and moving slowly forward. We also suspect that the burgeoning economic recovery in the region, showing increasing signs of broadening, will gradually take the sting out of the extreme ends of the political spectrum. In the meantime, we see those constitutional restraints successfully containing those same forces.
All this adds up to a continuing preference for stocks over bonds in the region, with a leaning towards financials, industrials and energy in both the core and the periphery. Those firming prospects for growth and inflation, in France as well as the rest of the region, remain our primary focus. Messy politics may provide trading opportunities, but will not be strategically definitive in our view.