Macron: Reasons to Believe

Even at current multiples, we believe there exists the potential for some notable medium-term returns in the French market.

French President Emmanuel Macron provided us with one of the iconic images of the summer of 2018: his delight in the French team’s World Cup victory infectious and heart-warming, his locker-room celebrations with the team a vision of unfeigned patriotic delight that swiftly went viral. It was yet another reason to admire a President whose first year in office has been eventful and, in many areas, highly impressive.

The changes to France’s labour laws affected last year have had an immediate impact on how small businesses operate in the country, delivering certainty where previously there was chaotic ambiguity. Most importantly, Macron’s steps have put a cap on how much it costs firms to lay staff off, tied to length of service. Where once every redundancy was decided entirely by a local judicial review, those judges now have to operate within pre-set parameters, meaning that entrepreneurs are able to plan more exactly and implement savings more efficiently when required.

Macron also forced through changes to contracts for workers at the state-owned railway, Société nationale des chemins de fer français ('SNCF'). While the amendments only apply to future hires and not legacy contracts, the significance of the move cannot be overstated. SNCF employees previously enjoyed the same degree of protection as French civil servants, meaning that they could effectively never be fired. The end of the idea of the job for life for workers employed by the state is, in France, truly revolutionary.

This is the real achievement of Macron’s tenure so far: enforcing changes that were previously unimaginable. When Macron set out on this series of reforms, many said the reforms simply could not be achieved; that he would run into the same problems as Jacques Chirac and his Prime Minister, Alain Juppé, when in 1995 they tried to implement a series of public sector changes in order to address a gaping budget deficit. The country was brought to a standstill by a series of rolling strikes which eventually led to the reforms being shelved. Macron’s steps to date have been achieved with relatively little public outcry.

Another telling moment of Macron’s first year in office was the repeal of the wealth tax on all assets (save real estate) and the implementation of a flat 30% tax on financial income. These reforms have confirmed him as a favourite of the financial markets, something evident from the multiples achieved by mid-cap French stocks. We look at the mid-and-small-cap index here as a more accurate measure of the domestic economy – firms in the CAC 40 Index tend to have much more international profiles. Figure 1 shows that, despite substantially inferior return on equity, current and estimated price-to-earnings ratios for mid-cap French stocks are superior to those in Germany or the UK, while price-to-book ratios are comparable. This shows the faith investors continue to place in Macron and his ability to drive his agenda through to its conclusion.

Figure 1. Comparing Multiples Across France, UK and Germany
Index 2018 2019 2018 2019 2018 2019
France CAC MID SMALL 22.2 16.9 7.5 8.6 1.8 1.7
UK FTSE 250 14.9 13.5 11.0 11.4 1.9 1.7
Germany DAX MID-CAP 18.3 16.8 11.9 11.4 2.0 1.9

Source: Bloomberg, as of 21 August 2018.

Such confidence is testimony to Macron’s charisma and the clear potential inherent within the French economy.

Yet, we should not allow the President’s telegenic presence to blind us to the fact that the reforms that have taken place will need some time to feed through, while the most meaningful and potentially controversial steps are still to be implemented.

Currently, the country’s economic performance is disappointing. Unemployment is moving in the right direction: It peaked at 10.4% in 2015 and stood at 9.1% in the second quarter of 2018.1 However, recent GDP growth has underwhelmed, hitting a mere 0.2% quarter-on-quarter in both the first and second quarters, behind both the UK (0.2% and 0.4%, respectively) and Germany (0.4% and 0.5%, respectively), according to Trading Economics. Given the amount of systemic stimulus from the European Central Bank’s bond-buying program, this growth is lackluster (although the figures may have been impacted by the relatively limited SNCF strikes that took place in the wake of the contract reforms).

The next step in Macron’s agenda is the simplification of the pension system. Currently, a fiendishly complex and convoluted series of regimes that offer significantly superior pensions to some occupations while penalizing others, Macron’s catchphrase of “one euro contributed gives rise to the same rights for all” seems straightforward enough. This is to underestimate the incredibly charged nature of discussions surrounding pensions in France and the President’s falling domestic popularity (his charming reaction to the World Cup win notwithstanding). The coming months will provide the real test of Macron’s ability to mold France’s economy into one that will allow it to compete effectively in the 21st century.

Macron’s moves so far have, as we said above, impressed us, but let’s play devil’s advocate for a moment: Is the President as committed to wholesale reform as he makes out? In the end, and for all that is made of Macron’s (relatively brief) investment banking career, he spent the majority of his career working for the government. Macron and his Prime Minister, Edouard Phillipe, both attended Ecole Nationale d’Administration ('ENA'), the elite training school for French civil servants. It’s striking that the changes that have been made so far have all been targeted to boost productivity of the private sector in order to increase the revenues available to fund France’s bloated public sector, rather than reforming it wholesale. Despite the size of the public sector, civil servant employee numbers in the 2018 budget are forecast to remain at their current level. It’s hard to escape the feeling that Macron, a product of the civil service, is rather more wedded to it than some of his cheerleaders in the financial markets might like to believe.

Indeed, the public sector in France is proportionately larger and more expensive than any other major economy in the world. Public sector spending has risen precipitously over the past two decades to stand at more than 56% of GDP in 2017,2 almost 10 percentage points higher than the Euro-area average.3 The response to this is often that the public sector does so much more in France than elsewhere, running the hospitals, much of the transport network, almost all of the schools and universities, as well as the vast pension system.

This, though, is the problem: the model of public ownership has been largely overthrown elsewhere because it is so profoundly inefficient. If Macron genuinely wishes to make France globally competitive, he needs to recognize that the current model is severely challenged to say the least. Rather than trying to fund it through increasing the contribution of the private sector to state coffers, we believe he should focus on the cost side of the equation.

Figure 2. France Government Spending to GDP

Source:, as of 31 December 2017.

The changes made to date have been real and far-reaching but also the easiest to sell to a skeptical French public. Pension reform and any attempt to reduce the size of the public sector, on the other hand, may risk far more of a sustained backlash. Macron’s market-friendly moves have already seen him branded the president of the wealthy. It’s not hard to see both the right and left capitalizing on further public dissatisfaction with a president who promised so much but is yet to deliver changes that will really make a difference to the future of France. The markets are already rewarding Macron for his achievements to date; it is our belief that the most significant tests are yet to come.

Yet, for all this caution, we see several reasons for optimism when it comes to France. Macron has already surprised on the upside when it comes to winning round an intransigent public. Polls suggest that most French still support the idea of reforming the convoluted pension system, even if the devil will be in the details. The opposition on both sides of the political divide is weak and fragmented, buying Macron time to implement the changes he needs to make. The strength of the private sector has been impressive so far and, if the burden of the public sector on the economy can be lessened, we believe that even at current multiples there exists the potential for some notable medium-term returns in the French market.