I have just returned from a three-week visit to Paris and more generally to France, where I lived for 27 years, the major part of my professional life. I found much that is unchanged – aspects that continue to lead me to rank Paris first among the globe’s cities. However, I also found a city and country in which the citizens have a number of valid reasons to be concerned about the future. An elderly French friend told me he feels conditions haven’t been this bad since the war. This was probably an exaggerated view, but it is suggestive of other attitudes I have heard and read.
For the visitor, Paris and France are still lovely, and the food and wine remain memorable. All tourist venues were packed. During the fall fashion week, boutiques were filled with shoppers willing and able to pay shockingly high prices. Lines at the museums were long. Restaurants were doing very good business. If one does not read or watch the news or talk to the citizens, one might get the impression that all is well. The truth for the citizens of Paris and of France, unfortunately, is rather different.
The problems confronting France today constitute a depressing combination of economic, political, social, and security concerns.
The French economy is the second largest economy in the Eurozone and the fifth largest in the world, following the US, Japan, China, and Germany. Thus French economic developments have importance beyond that country. The French economy is lagging the weak recovery in the Eurozone and stagnated in the first half of this year. Leading indicators suggest this stagnation continued through September, with both manufacturing and services production still contracting. The difficult political situation and uncertainty about future policies discussed below is depressing the business climate, despite a certain improvement in the dialogue between business and government. Business investment is likely to be negative for the current year. The unemployment rate remains stubbornly high, above 10%, with 22.5% of young workers now jobless.
Having failed thus far to carry out needed economic reforms, France continues to lose competitiveness. Net trade will make a negative contribution to the economy this year. Next year will not be much better, despite the boost from a weaker euro, as labour costs rise relative to those in other Eurozone countries. All efforts to carry out market-oriented reforms encounter stiff resistance, very often leading to strikes.
The French are very good at saying “No,” at opposing change even when doing so is like ordering the tide to stop rising. During our visit, France’s lawyers (for the first time) and other regulated service professionals were in the street protesting reform plans that would introduce a little competition into the setting of their fees. On September 30th almost all pharmacies were closed to protest the government’s plan to permit supermarkets to sell some medical products. And through most of our stay we experienced the very French annoyance of worrying about the length of a strike mounted to resist market forces. Air France pilots carried out a lengthy and financially damaging strike against the airline’s efforts to remain competitive by expanding its low-cost affiliate. In the end the pilots were granted most, but not all, of their demands – at the cost of significantly harming the future market for Air France.
Looking beyond the current year, the French do not have very encouraging economic prospects. Growth in 2015 is unlikely to top 1%. For the following several years, annual growth rates below 2% are projected. With public debt still at unsustainable levels, the government has little room to pursue fiscal stimulus. Indeed, the French Finance Ministry has indicated yesterday, October 1, that it will maintain its commitment to reduce the budget deficit, cutting annual public spending by 50 billion euros ($63 billion) by 2017. The only apparent avenue for catching up with the more dynamic European economies such as Germany and Spain is to undertake urgently needed structural reforms.
The current political climate affords little basis for optimism. President Hollande’s popularity is down to the low 20s, the lowest for any postwar French president. It seems he can’t get a break (e.g., when he tried to sneak off to his girlfriend on a motor scooter, concealing his face in a helmet, the press identified him by his shoes). More seriously, his legislative attempts at modest reforms have been poorly managed, with bills having to be withdrawn because they were not well drafted. It is evident that Hollande lacks the ability to lead and achieve results even in cases where his ideas are sound.
In elections last Sunday the center-right parties gained control of the Senate. While that body is not nearly as powerful as the US Senate is, it will be able to make Hollande’s quest to achieve his reform agenda even more difficult. A more disturbing result in the vote last Sunday was the success of Marine Le Pen’s National Front party, which for the first time gained two seats in the Senate. This follows the National Front’s recent successes at the European and local levels. While Marine Le Pen has sought to make her father’s party somewhat more respectable, its anti-Semitic and anti-immigrant roots have not disappeared.
The increased support for the National Front happens at a time when there has been a sharp increase in anti-Semitic incidents in France. These appear to have been related to the recent conflict in Gaza. I understand that, despite the increased dangers in Israel, the number of French citizens emigrating from France to Israel is at a record level this year. Part of my time in Paris I stayed in an area with large Muslim and Jewish communities living in close proximity. On the surface, life there seemed peaceful. Across the street there was a Muslim butcher shop next to a kosher food market. However, I was told there have been incidents, including attacks of sufficient severity that many Jewish residents feel unsafe for the first time and would like to move, preferably to the US or Israel. This is one of the developments in Paris and France that has worsened in the nine years since I left, and it is indeed sad.
The security situation has become a concern for all Paris residents. France was quick to join the US in air strikes against the jihadist ISIL forces in Iraq. A French friend was pleased to be able to say to me, “I am glad we are again allies, fighting together.” But its involvement means France is now more vulnerable to terrorist attacks. French solders are again evident in the metro and the airports. Like the US, England, and Germany, France fears the return of ISIL militants. France has the largest Muslim population in Europe. While most of France’s Muslims are moderates, the immigrant ghettos, with very their high youth unemployment rates, have been fertile ground for recruiting new jihadists.
A week and a half ago France awoke to find that the newspapers and TV news all had the same picture, that of Herve Gourdel, a French mountain guide who was brutally murdered (his beheading captured in a four-minute film) by jihadists in Algeria. There was universal shock, as there had been in the US and Britain in similar recent cases. I think the French were very surprised at how quickly after Gourdel’s capture the killing was carried out. They had anticipated a period of negotiation and possible action to liberate the man.
The barbaric execution, as the French referred to it, strengthened French determination to strike ISIL in Iraq, and a decision to join the US and Arab states in hitting them in Syria is likely. There is considerable pride evident in this action. A positive development last Friday and over the weekend was the reaction of the Muslim community, led by Muslim religious and political leaders. In Paris and other cities there were demonstrations of support for France and a strong rejection of ISIL by France’s Muslims, who were joined by religious leaders of all the major faiths. Typical among the statements issued was this one (rough translation): “France is our republican family. We, the Muslims of France, are all Herve Gourdel. He is living among us. One cannot support the mentally ill people who defile our religion.” It was encouraging and moving to see the French standing together to confront this challenge.
At Cumberland Advisors we do not hold France-specific ETFs in our International and Global portfolios and are underweight with respect to the Eurozone. The one France equity market ETF available on the US market is the iShares MSCI France ETF, EWQ. It is down 6.7% year-to-date, a slump much worse than the 2.6% decline of the iShares MSCI ACWI ex-US ETF, ACWX, which covers all markets outside the US. However, the decline in the French ETF is a little better than the 7% decline of the iShares MSCI EMU ETF, EZU, which covers the Eurozone markets. This may seem surprising in view of the lagging performance of the French economy. The explanation lies in the heavy weights of the internationally oriented financials (17.8%) and industrials (17%) in the MSCI France Index tracked by EWQ.
A negative factor heavily affecting the US-dollar returns of all unhedged Eurozone ETFs has been the recent decline in the euro/US dollar exchange rate. This trend may well have further to go. The WisdomTree Europe Hedged Equity Fund, HEDJ, which we do hold, is up 2.8% year-to-date.