French stocks still haven't priced in the trouble that bonds have, argues Citi

Citi argues French equities have not fully priced in the political instability surrounding Prime Minister Francois Bayrou's anticipated loss in a Sept 8 confidence vote, a risk already largely discounted by French government bonds (OATS). While OATS yield spreads over German bonds widened to 80 basis points, with Citi forecasting a potential increase to 90-95 bps upon Bayrou's defeat, the stock market has yet to fully reflect the heightened risk of governmental paralysis and a possible snap election. This suggests French stocks may be poised for further adjustment to the political uncertainty.

Analysis

Citigroup's research highlights a significant divergence in risk pricing between French government bonds (OATS) and the country's equity market ahead of a critical confidence vote on September 8. The analysis indicates that the bond market has already substantially priced in the high probability of Prime Minister Francois Bayrou's defeat, evidenced by the 10-year OAT yield spread over German bunds widening to 80 basis points. Citi forecasts this spread could expand further to 90-95 basis points should the government fall, triggering a snap election. Crucially, the report argues that French equities have not yet fully absorbed the implications of this heightened political risk and the potential for governmental paralysis, suggesting the stock market is vulnerable to a negative repricing event as it catches up to the reality already reflected in sovereign debt.

Key Decisions for Investors

• Investors with long exposure to French equities should consider reducing positions or implementing hedging strategies to mitigate downside risk from the anticipated political instability.
• Monitor the French OAT-German Bund 10-year yield spread as a key leading indicator; a widening towards the 90-95 basis point level would likely precede a correction in the equity market.
• Prepare for heightened volatility in French stocks surrounding the September 8 vote, which could present tactical shorting opportunities if the government loses the confidence motion as expected.