For Traders from Club iNSIDER: Political and fiscal uncertainty call CAC’s valuation into question

French stocks face P/E risk amid economic and political woes. Valuations of French stocks, especially large companies, appear overvalued relative to global peers, with weaker earnings support and potential risks related to political instability. The performance of banks and industrials following snap elections signals the greatest potential for P/E upside relative to their EU peers, although a worsening economic outlook for 2025 and fiscal tightening could dampen investor enthusiasm.

1. CAC P/E ratio hits 10-year high

The CAC’s valuation upside appears limited without stronger earnings momentum, better political stability and a more resilient economic environment in 2025. The index’s absolute P/E ratio is just below its long-term average of 13.2x, putting it back to the levels it saw in the first half of the year before the French snap elections. However, the relative P/E ratio to the Stoxx 600 is trading at the same level and close to 2 standard deviations above 10-year norms. This high valuation is mainly supported by the weaker momentum of the French index’s earnings relative to the broader European market and is at risk if the cyclical recovery fails.
A vote of no confidence from the far-right and left parties on the budget could lead to the government’s resignation.

2. Valuations of large French companies are overvalued relative to peers

Valuations of large French stocks appear particularly high relative to their US, Japanese and European peers and could be at risk without a stronger earnings recovery. CAC’s forward P/E ratio (forward P/E divided by the 24-month EPS CAGR) of 1.9x is the highest among global peers. The MS190 (French mid- and small-cap stocks) ratio of 0.4x is closer to peers (0.1-0.9x), but the index’s higher internal exposure makes its earnings growth and valuation more sensitive to economic downturns and political changes in France, especially after Barnier announced fiscal tightening plans in October.

Our economists have lowered their forecast for French GDP growth in 2025. to 0.7% from 1.2%, with the new budget plan – if implemented – potentially reducing growth by another 0.2 percentage points.

3. Sentiment appears subdued amid fiscal policy uncertainty

Our fair value estimate implies 8% upside to French equity valuations on a current P/E of 13x, but the market is pricing in weaker economic growth and heightened sovereign risk. Barnier is likely to struggle to push through fiscal plans to reduce the budget deficit given a divided government that could keep 10-year yields high, while expectations of more ECB rate cuts could push 2-year yields lower. If the spread between the 10-year and 2-year yields widens to over 100 basis points and economic sentiment worsens further, CAC’s P/E ratio could fall to around 13x according to our regression model.
The model is a multiple regression analysis using the spread between the 10-year and 2-year yields of France, corporate spreads of BAA and the EU economic sentiment indicator (R-squared 0.69).

4. French banks and industrials have the most potential

A reassessment of industrials and – in particular – French banks will require a brighter economic outlook. French lenders (BNP Paribas, SocGen, Credit Agricole) have lagged the European banking index (SX7P) this year, both before and after the snap elections in June. Higher tax proposals in the government’s new budget plan could hurt domestic demand and business activity, weighing on credit volumes and increasing credit losses.

On the other hand, stronger sentiment towards the aerospace and defense (Airbus, Safran, Thales) and construction (Saint Gobain, Bouygues, Legrand) segments will require higher EU defense spending, as well as a recovery in housing construction. (25.11.2024)

5. Widening yield spread between France and Germany signals market uncertainty:

6. CAC Still Hasn’t Recovered from Post-Sudden Election Drop: