France’s $2.4 trillion economy is the sixth-largest in the world and vital to the continued viability of the European Union. Le Pen has indicated a desire to leave the EU and drop the euro.
“Macron’s first-round victory sparked a ‘risk-on’ rally in the markets around the world,” noted Neena Mishra, director of ETF research at Zacks Investment Research. “Investors are already betting that political risks have disappeared and have been pouring money into European ETFs.”
In the past one-year period through May 3, the iShares Core MSCI EAFE ETF (IEFA) has taken in more than $11 billion. Its taken in more than $6.5 billion already this year. The Vanguard FTSE Developed Markets ETF (VEA) is above $6 billion this year as well. These ETFs are roughly 45 percent European developed markets stocks. These two ETFs have together taken in as much this year from investors as the No. 1 ETF, the iShares Core S&P 500 ETF (IVV). The EAFE index has outperformed the S&P 500 this year, 11.7 percent vs. 7.4 percent, according to Morningstar data. The much smaller, iShares MSCI France ETF (EWQ) is up 14.6 percent this year and 18.5 percent in the past year.
This big move into European stocks could come back to haunt investors.
“The rally we had following the first round of the French election on April 23 sets investors up for major disappointment if far-right leader Le Pen wins,” said Mitch Goldberg, president of investment advisory firm ClientFirst Strategy. He said investors generally do well by brushing aside big events, mostly because either the bad event never comes to be or if it does, it isn’t nearly as bad as anyone expected.
“Brexit and the Trump presidential victory are two glaring examples of that,” Goldberg said. But he added, “I’m concerned that investors are getting a little too used to whistling past these events, a little too complacent. Bear markets are a part of investing, but investors clearly aren’t in the mood to prepare for one.”
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Unlike Britain, which never adopted the euro and has long stood figuratively and literally apart from mainland Europe, France is integral to the EU. That means the “consequences of ‘Frexit’ would be far more severe than those of Brexit,” Mishra said. “The European Union can survive without Britain, but not without France. France is a core member of the union. If Le Pen wins, markets around the world would start pricing in Frexit risks.”