This Sunday, May 7, 2017, French voters will choose between a mainstream independent presidential candidate (Emanuel Macron) who embraces European integration and cooperation with the U.S., and an anti-establishment presidential candidate (Marine Le Pen) who criticizes France’s current alignment with Europe, appearing to favor closer ties with Russia.
Though polls and party politics suggest Macron is the clear favorite, it is prudent to contemplate the impact of a Le Pen victory, which could follow recent British, American, Italian, and Dutch elections that have challenged the political status quo.
Most relevant for investors, a Le Pen victory in France would further challenge the global political consensus in favor of free trade that has helped fuel stock growth over the past several decades.
This consensus, supported by both liberal and conservative political parties in U.S. and Europe over at least the last 25 years, has produced policies that have increased global trade, fueling corporate profit growth and decreasing global poverty by creating impressive economic growth in “emerging” markets like China and India.
Unfortunately, these same positives have been accompanied by stagnant or declining real wages for most people in U.S and Europe – fueling a political backlash that in hindsight appears almost inevitable.
Yet, even as voters in the U.S. and Europe have elected candidates promising to challenge free trade agreements, stock markets have risen. This may be because investors believe politicians need to avoid threatening the millions of jobs created in developed countries by the growth in global trade since the 1990s.
Markets may also have held steady because most investors are invested for the long term, and understand that even if there is a geo-political event that drives down stock markets in the short term, there are good reasons to believe that stocks will regain their value and continue their upward trend. Ultimately, this conclusion is grounded in a recognition that consumers in emerging markets, want to realize the same material comfort as people in developed countries, and will thus buy more as their economies grow, fueling corporate profits along the way.
But even though we think a Le Pen victory is unlikely to be a “last straw” sending stock markets tumbling, the dramatic headlines warning about that possibility should remind investors to make sure their portfolios should always be designed to expect the unexpected.
Geo-politics is only one source of threat to markets – for instance, the International Monetary Fund (IMF) recently warned that rising corporate debt levels, now as high as they were prior to the financial crisis, are a source of market risk.
This is why McKinley Carter aims to construct client portfolios that:
- Focus on companies with consistent earnings growth and strong balance sheets that we expect to do better in declining markets;
- Demonstrate broad diversification to avoid the adverse impact of a rout in any particular country, industry sector, or company;
- Include a sufficient allocation to high quality bonds so that anticipated needs for distributions can be funded without a forced liquidation of stocks during a major selloff (which will occur again we just don’t know when); and
- Do not expose a client to more downside risk than we believe that client is willing to endure for the sake of having more growth potential over the long term.
To strike the appropriate balance between growth potential (which is advanced by a higher allocation to stocks) and protection from steep market declines (which is advanced by a higher allocation to high quality bonds and alternatives), it is critically important that our advisors are as up-to-date as possible regarding your total financial situation.
Though stocks have more than doubled in value since 2000, it is important to remember that along the way, stocks represented by the S&P 500 Index declined over 50% on two occasions, (and nearly 14% at one point last year). If your situation, including your willingness to experience that kind of volatility has changed since you last met with your advisor, please use the remote, but real, possibility of a Le Pen victory as motivation to contact your McKinley Carter advisor to discuss the trade-offs associated with appropriate alternatives.