France is an economic basket case. It struggles with chronic unemployment of about 10 percent. Those who do have jobs don't like to work much. The economy is rigid, with government ownership prevalent in key industries. Entrepreneurs flee burdensome regulations to create businesses in the United Kingdom and the United States. In recent months, France lost the lucrative 2012 Olympics to London, and an angry electorate resoundingly voted down the establishment's pet project, the EU constitution.
So, how can it be that in this year of woe, the French stock market is kicking our derrière—and the derrièresof many other countries?
Thus far in 2005, U.S. stocks have struggled against the fierce head winds of rising interest rates and the rising cost of oil and other raw materials. French companies operate under many of these same constraints. And yet among the G-7 (the seven largest economies in the world), France's stock market has turned in the best performance so far this year in local currency terms. As of yesterday's close, France's CAC-40 index was up 15.78 percent. That noses out Germany's DAX 30, which is up 15.4 percent. By contrast, England's FTSE 100 has gained 9.6 percent, and the U.S. indexes are either flat or down. Check out this chart of the CAC-40 against the Dow Jones Industrial Average, the S&P 500, and the Nasdaq. The CAC-40 has seemed to gain momentum even as France's ordeals piled up this summer—it is up about 8 percent in the last few months.
Several macroeconomic and psychological factors are at play here. One is interest rates. U.S. short-term interest rates have risen sharply in the last year, as Federal Reserve Chairman Alan Greenspan continues his campaign to return rates to normal levels. That works against our bourses in two ways. With yields on short-term bonds and savings accounts rising (at about 3.5 percent), these safe instruments provide an increasingly attractive alternative to poorly performing, riskier stocks. Rising interest rates are also bad news for banks and financial services companies, which account for a huge chunk of the S&P 500.
But in France—and the Eurozone at large—interest rates are significantly lower. The European Central Bank's overnight rate is 2 percent, compared with the Federal Reserve's 3.5 percent rate. And since Europe's central bankers are more concerned about slow growth than runaway inflation, investors think European interest rates are more likely to fall or remain constant than to rise. That's inherently bullish for stocks.
A second economic reason: The CAC-40 consists of the 40 largest France-based companies. Most are multinational titans like Alcatel, BNP Paribas, luxury-goods giant LVMH, grocery store operator Carrefour, tire behemoth Michelin, and L'Oreal. Just as many of the largest U.S. companies—Coca-Cola, General Electric—rely on foreign markets for most of their sales and growth, most of these French champions are truly global. In many instances, they've proved just as adept at competing in global branded markets as their U.S. rivals. And so while the French market stagnates, these corporations are able to grab a fair share of growth in rapidly growing markets like China and India.
There's some psychology at work here, too. Stock markets are future markets, not present markets. Pessimism has long ruled the day in Germany and, to a lesser degree, in France.But in recent months, contrarian investors have become more optimistic about the economic future of Old Europe. People figure things can't get much worse, so why not take a plunge?
Nouriel Roubini, a professor of economics at New York University's Stern School of Business who runs the influential Roubini Global Economics Monitor, says France's structural rigidities may be exaggerated. "The 35-hour work week has effectively been phased out." he said. And there's increasing optimism that Interior Minister Nicolas Sarkozy will spearhead greater structural reform.
But the real grounds for optimism lie in the restructuring work being done by individual companies, not by governments. In August 2004, Ben Funnell, a London-based Morgan Stanley equity strategist, presciently argued that European stocks were poised to outperform U.S. stocks. And he's still bullish. He notes that French businesses—and European companies on the whole—are finally starting to do what U.S. companies did long ago: cut jobs, aggressively restructure operations, outsource, expand in low-cost overseas markets, and focus on profits. "Productivity in the U.S. is starting to slow, whereas it's starting to rise in Europe," said Funnell. "And that's being driven by better progress on company-by-company reform than we had anticipated." That bodes well for European corporate profit growth. And even after their recent run-up, French stocks trade at a comparatively low multiple to earnings.
Funnell notes a final factor weighing in favor of investing in France: European economies are far less sensitive to the price of oil than the U.S. economy. "In Europe, 80 percent of the pump price is tax," said Funnell, "whereas in the U.S., it's 20 percent." In other words, when the price of crude oil rises, as this chart shows, it will have a greater impact on the stock of Wal-Mart than on Carrefour.