Luca Paolini (Pictet): “France may be ungovernable, but that is better than an absolute right-wing majority” | Financial Markets

Luca Paolini (Pictet): “France may be ungovernable, but that is better than an absolute right-wing majority” | Financial Markets
Luca Paolini (Pictet): “France may be ungovernable, but that is better than an absolute right-wing majority” | Financial Markets

The rationality of the markets comes to the fore in turbulent political times. With the far right at the doors of the French government, and the lessons of the debt earthquake that brought down Liz Truss in the United Kingdom still fresh – so much so that they explain, in part, the overwhelming Labour victory this Thursday – Luca Paolini, chief strategist of the Swiss investment firm Pictet, insists on a recurring idea: the markets do not like populism. They appreciate solid policies and legal certainty, and will give a premium to whoever is able to carry them out. The executive points, in line with all the firms in recent weeks, to the new market trends: corporate debt and the European stock market.

The call for early elections in France has caused strong movements in the markets. After the first round (with a temporary victory for Marine Le Pen’s far right), what do you expect for this second round?

What matters to the markets are surprises, and the victory of the far right in the first round was predictable. If there have not been any major moves now, it is because the French system is very difficult to predict, given the two rounds. The market’s feeling is that the tacit alliance between Macron and the left will prevent an absolute majority for Le Pen. This will make the country ungovernable, but it is perceived by the markets as a better result than an absolute majority for the far right. As for the French risk premium, we do not expect the price of the bond to fall much. There is a new normal in its risk premium, which is around 80 basis points, and we believe that it will remain that way because France’s fiscal situation is incredibly challenging.

We are in an election year, with elections in the United Kingdom, India and France that will define the policies that will shape the coming years. Which markets or sectors should we focus on in the long term?

Over the long term, we expect the dispersion of earnings to narrow. The leadership factor will be lost. The question then becomes: What do I do if the market is very concentrated in the US and I expect most markets to behave similarly? Well, take weight off the largest market and diversify into others, such as Europe or Japan. We like Southeast Asia a lot, because it has a combination of high growth, low inflation and good valuations. And also because we expect business-friendly policies and less vulnerability to populism. Investors are going to pay significant premiums for sound policies. We see a trend towards more autocratic countries, less open to business, so those that do the opposite will be rewarded by investors.

The French crisis has put the spotlight on debt. Over the past two years, there has been talk of it being “the year of debt”, but it has not happened. Is this the time for fixed income?

We believe that in this cycle we have already seen government bonds hit their yield ceiling. The decline will be relatively mild, for the obvious reason that inflation is still there and growth is slowing, but not completely. We do not believe that there will be a buyer’s strike: the idea is that if the executives cannot control the fiscal situation, investors will stop buying. It already happened in the United Kingdom a few years ago. That said, yields are at levels that make bonds attractive. There is demand, also among retailers: if you have government bonds that pay 4% or 5%, with inflation around 2%, people are happy with that. People are getting older and will not have the security of a salary, and a bond like that, in an aging population, is very attractive.

Luca Paolini, chief strategist at Pictet, at its headquarters in Madrid.Samuel Sanchez

And what about corporate debt? It is not paying much better than public debt, despite the implicit risk, but it is also in high demand.

We must start from the fact that the spread between public and private debt is a risk average: if you look at the balance sheet of the private sector compared to the public sector, which is better? The public sector is highly indebted, while companies are in a good situation. The risk is lower. It is true that the spread between public and corporate debt is low, but we think differently: on the riskiest bonds in the US, you can get returns of 7% or 8%.

Corporate debt is probably the best asset for the next five years because we have a moderate decline in returns but at the same time high yields. And all this without having the expensive rotation of stocks. Compared to the stock market, it is cheap. Perhaps not especially cheap compared to government debt, but for good reason.

So what opportunities do you see in the stock market? The trend in recent weeks has been to say that the United States is expensive and that there are good opportunities in Europe.

The US is expensive, yes, thanks to the fact that there are several stocks that are pulling the markets strongly. They are mainly related to artificial intelligence. If you look at the median valuations, they are not that high. The thing is that there are companies that have incredibly high fundamentals, such as Nvidia. Basically, they are money-making machines, very difficult to value. You can’t expect this to continue forever, and the market probably thinks it will continue for too long. We opt for a more cautious view in the short term with technology and with the US. We reduced our positions to neutral a few weeks ago.

We are overweight Europe because we think the momentum is there. The recent economic data has been weak, to be honest, but what matters is the trend, and in the US the trend is down. In Europe you have a cheaper currency, rate cuts, and we have not yet seen a consumer trend like we have seen in the US. If you compare them, six months from now, Europe looks better. That said, there is still significant political risk and we are way behind on issues like artificial intelligence.

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