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The question comes with every change in governance: How do financial markets react to the prospect of a new five-year term. Will investors react to Macron’s mandate 2? Bertrand Jaquilat explains why the question no longer makes sense today.
Some investors may still have the backlash of wondering what the outcome of the French presidential election will be on the stock market. No doubt this question still had meaning fifty years ago when General de Gaulle criticized at a press conference that France’s policy was not rubbish. By the way, this warning implies that even for a person as remote as him from stock market issues, French policy can have an impact on the stock market.
This question no longer makes any sense today, nor is it an insult to those who are nostalgic about France’s influence as a global economic power. But the economy is not stateless. Some countries, due to their economic weight, have more influence than others, and this is the case especially the United States and China, which are the two main economic engines of the world. And the economy is not without a body either. There are a number of factors of particular importance.
These are primarily real interest rates and growth rates, which are grouped together in the basic equity valuation equation, the level of which is determined by the present value (interest rates) of cash flows (and their future growth) that companies generate. Of course, there are tools to operationalize these concepts, both at the level of individual stocks and markets.
‘We have to show them the money’
As far as the stock markets is concerned, this is the one that relates the expected rate of return on stocks to the natural alternative investment rate, which is the long-term bond rate. The term risk premium is often given to this difference, which has historically been around 5%, and has gradually increased to reach an average of around 7%. This spread reflects the relative interest in focusing on one of these two asset classes. Hence it provides particularly useful indicators when it deviates significantly from its historical average in one direction or another. It is weak, it encourages people to stay away from the stock market. What is the benefit of risking an additional discounted pay compared to a risk-free investment.
This was badly the case in the summer of 2007 on the eve of the subprime mortgage crisis. At less than 3%, it sparked a strong interest in giving up the stock market. On the contrary, at the end of March 2020, at the heart of the devastating impact of the potentially horrific epidemic outbreak, it was then more than 11%. After the strong price rebound that followed, the market premium returned to its usual levels. Despite fears of a recession and higher interest rates, the market risk premium is currently 6.8%, without giving conclusive indications.
What about individual values? Inflation fears and the end of expansionary monetary policies have halted excessive valuations of some technology stocks. This prompted the current president of Uber, Dara Khosrowshahi, to send the following message to his employees about the company’s shareholders: “We need to show them the money.”
This shift to financial orthodoxy from a company that hasn’t had a single profit quarter since its inception in 2009 speaks to a lot of new approaches to stock picking. It is a matter of moving away from companies whose only strategy was capital consumption and looking for technology companies whose development comes with strong cash flow. Their names are well known and they are well positioned in this unfinished cycle of innovation.