GLOBAL INVESTING: BNP Paribas and the black swans of France in 2017

Dubai - Will Le Pen win be a disaster for French equities and global stocks?

Springtime in Paris is a cliché but the spring of 2017 is a game-changer because France goes to the polls in April and May to elect a new president to replace the hapless François Hollande. With the Volatility Index at 11, I am certain that the stock market's fabled risk and fear pendulum does not remotely capture the risk embedded in global equities. True, the yield curve in the US Treasury and German Bund/French OAT market has steepened as global growth accelerates, inflation risks rise and eurozone PMI moves into the 55-56 range. If Emmanuel Macron wins the French election, French equities will soar in value.
What if the global populist wave, or a sordid scandal in the centre-right's presidential campaign and the "clash of civilisations" in the bidonvilles of Paris, Bordeaux, Lyons, etc, lead to a landslide win for the xenophobic, anti-capitalist, anti-EU, anti-Euro National Front candidate? A Marine Le Pen win will spell disaster for French equities and the global stock markets. In this scenario, I can easily envisage a 2,200-point or 25 per cent drop in the CAC-Quarante index in Paris. A Le Pen win would trigger a stock market crash, another spike in Club Med sovereign bond yields and a free-fall in the euro to 0.85 cents. The global safe-haven bid in the US dollar will plunge the world into recession. In this sense, Marine Le Pen could well be to 2017 what Lehman was to 2008, what the sterling-ERM crisis was to 1992, what the invasion of Kuwait was to 1990. A black swan event that triggers global panic. Bonjour tristesse!
Reveries aside, I have to trade and invest in the real world. I believe Le Pen will not win. So I accumulate French shares on any pre-election examples. BNP Paribas is France's "bank for a changing world", arguably the most undervalued corporate, private and trade finance bank in the Old World. I had last recommended BNP Paribas as a core holding in Europe back in the summer of 2012, when angst about Greek sovereign debt and the existential (Camus? Satre?) crisis of the single currency slammed the shares down to 29 euros. BNP Paribas doubled in the next five years before its recent mini-swoon in the stock market. My ideal buy level for the bank is 54 euros or a valuation of 9.5 times forward earnings and a dividend yield of 4.9 per cent, which would move the risk calculus so overwhelmingly in my favor as to constitute another asymmetric winner trade.
The investment rationale for BNP Paribas is compelling. BNP Paribas has deleveraged its balance sheet, derisked its funding profile, slashed its cost base, boosted its Basel Tier One capital adequacy ratios, increased its returns on equity and accelerated its dividend payouts/share buybacks. Even in the ooh-la-la world of French haute finance, shareholders understand the alchemy of le operating leverage (a concept as near and dear to the Gallic soul as le weekend!) all too well. The gnomes of La Defense at the "banque rouge-noir" alone see 2.7 billion euros in operating cost cuts by 2020.
True, fourth-quarter profit estimates disappointed the markets. Retail banking in France is a mature, low return, low growth, thankless (thousands of 35-hour workweek functionaries from Cherbourg to Cannes, Calais to Carcassonne. quelle horreur!). I also cannot grasp why BNP Paribas has not sold Bank of the West, let alone Banca Nazionale del Lavoro. Yet it is surely significant that BNP Paribas managed to increase net income by 15 per cent and reduce the cost of risk by a stellar 46 basis points or 14 per cent. BNP Paribas also accomplished the holy grail of global banking, organic capital generation. For instance, the Common Equity Tier One capital ratio for Western Europe's most valuable bank is now 11.5 per cent, an amazing metrics in a low interest rate, revenue growth malaise milieu. I was impressed that BNP Paribas reduced its cost of risk despite Italy's banking woes, a testament to the risk controls in its loan underwriting/origination. In addition, the liquidity reserve for the bank is 305 billion euros, prima facie evident of low wholesale funding risk. Book value is 73.9 euros, my target for the bank in 2018!
The writer is a global equities strategist and fund manager.