In spite of the multitudinous headwinds facing the French economy, the CAC 40 equity benchmark is likely to trade sideways or see improvement over the coming months as the outlook for the Euro currency continues to weaken.
The biggest monetary policy divergence in decades is likely leading to a rapid appreciation of the US dollar and by extension a substantially lower Euro. However, the long-term outlook for the French economy and industry is likely to weigh on the CAC 40 going forward, capping any potential upside as growing political indecision and weak fiscal policy contribute to instability.
Fundamentals Showing Serious Stress
The Euro Area’s second largest economy has struggled to regain its footing since the spread of the sovereign debt crisis. France has notoriously been one of the least competitive regions economically within the common currency owing to many onerous business conditions and problematic labor regulations.
The banking sector has avoided many of the crises facing other regional financial institutions due to high nonperforming loans with bad loans as a percentage of the total currently numbering 4.30% according to the latest figures from the World Bank.
Aside from manageable levels of bad loans, credit growth to both the private sector and consumers has been relatively stable. However, one area that the Government has been unable to tackle is unemployment.
France’s unemployment rate in many ways mirrors the average for the Euro Area, currently sitting at 10.60% compared to 10.70% for the aggregate monetary union. However, in stark contrast to the recent improvement in Euro Area unemployment, France’s unemployment rate continues to rise as the austerity driven government budget fails to provide fiscal stimulus to improve economic fundamentals.
The area in which this is most evident is GDP growth which printed at a feeble 0.30% in the third quarter with the economy expanding at a 1.10% annualized pace. While the government is working on passing a series of reforms intended to restructure the labor economy and increase global competitiveness, these measures are still only theoretical and yet to be implemented.
Until adequate fiscal stimulus measures are introduced along with the reorganization of business regulations, growth is likely to remain slow.
From the perspective of the French CAC 40, economic headwinds continue to drag on the outlook for publicly traded corporations. With a price-to-earnings ratio of 21.7, the CAC 40 appears to be slightly overvalued relative to more historically normal levels.
A 1-year return of 7.36% is pretty substantial, but in many ways reflects the fact that the Euro has lost nearly -10.46% over the same period, with a weaker Euro European stocks cheaper making, giving added value on a relative basis to investors and an impetus to buy.
Should the Euro continue to decline, the inverse correlation is likely to remain intact, providing tailwinds for sustained upside in the CAC 40. However, it should be noted that the CAC will remain sensitive to prevailing economic conditions, setting the stage for a prolonged period of horizontal movement in the index.
Technical Outlook Biased Lower Despite Mixed Signals
Even though the French CAC 40 has shown gradual improvement, rising well off December lows, the index still has substantial downside risks that could cap any rebound in the March futures contract. Even though the relative strength index is in the middle of the range and trending higher in an indication of potential for further upside in the CAC 40, the moving averages tell another tale.
With the 50-day and 200-day moving averages trending to the downside and still above current prices, they may act as stubborn resistance levels preventing gains. Should the CAC 40 manage to overcome these levels, it could be viewed as a bullish sign and strong indication of an upside reversal.
However, the fact that the shorter moving average crossed the longer-term moving average to the downside is commonly referred to as at the “death cross” for its impact on price action. The crossover back in September is typically accompanied by substantial losses and traditionally serves as a hyper-bearish indication.
With the prevailing fundamental and technical factors in mind, traders want to take cues on trading the CAC 40 namely from the momentum in the Euro and initiate positions based on the directional trending tendencies of the moving averages, both short and long-term.
With risks firmly biased to the downside, the optimal play might be fading potential rallies higher. Any sustained gains that see the CAC 40 overcome the moving averages and in line with the prevailing RSI trend could contribute to further momentum higher in the index, propelling the CAC 40 back towards multi-year highs seen earlier in 2015.
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