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Barty argued in The Trump Inflection, Le Pen’s victory has the potential to be even more of an earthquake for the world’s financial markets. Indeed, we have already seen a 1vol move in April 2017 V2X futures since last month. So our central case is French political risk caps markets to the upside for Q1 and most of Q2 but that the centre right candidate Fillon is elected President. As Gilles Moec argues, his pro-market reformist agenda could unlock French growth and we think it could prove a significant positive catalyst for European equities more broadly if the political risk premium is priced out against a solid European and global growth backdrop. More of the same expected in Germany We think Germany carries less political risk than the French election now that Merkel has formally announced she will run again to be Chancellor. As a result, our central case is that Merkel will continue to head a coalition government. We could see the populist AfD win more votes than in 2012, but polls show a clear and decisive margin in favour of the CDU and the existing coalition with the SDP suggests that an extension of their partnership is the most likely eventuality. Chart 39: German polls show a consistent lead for Merkel’s CDU party 40 9 tg on Oe8e one go ghee 8,048 wa* Satan 24 20 a, 30 7 4-4 a a 6 a a 4 a4 4 25 ; 90 LU YOY Gar Thy yee iy y ony TT TY Gy a a 10 04000000004R 2,0044nnnnsassasasabasansannaa a*a September 2 September 5. Septembe: Septembe: Septembe Septembe: Septembe: Septembe Septembe: Septembe: Septembe Septembe: Septembe: November November 2 November 4, 20 November 7 November 9, 20 November 10 November 14, 20 November 19 November 22, 20 Source: Allensbach (15-Sept, 13-Oct), Emnid (7-Sept, 14-Sept, 21-Sept, 28-Sept, 5-Oct, 12-Oct, 19-Oct, 26-Oct, 2-Nov, 9-Nov, 19-Nov), Forsa (2-Sept, 9-Sept, 16-Sept, 23-Sept, 30-Sept, 7-Oct, 14-Oct, 21-Oct, 28-Oct, 4-Nov), Forschungsgruppe Wahlen (22-Sept, 13-Oct, 27-Oct, 10- Nov), GMS (14-Sept, 12-Oct, 12-Nov), Infratest dimap (21-Sept, 5-Oct, 19-Oct, 2-Nov), INSA (5-Sept, 12-Sept, 19-Sept, 26-Sept, 3-Oct, 10- Oct, 17-Oct, 24-Oct, 2-Nov, 7-Nov, 14-Nov, 22-Nov), Ipsos (10-Oct) Brexit was the big political topic for Europe going into 2016. Going forward we see it as an ongoing issue but mostly for the UK (see UK — Waiting for Brexit for more details). Rising bond yields & equities With the market focus on the sharp bond market sell-off it is worth re-visiting the links between equities and bonds as many investors question whether the effect on equities will become negative the more yields rise. An environment of rising bond yields is not inherently problematic. Over time correlations between bond yields and equities have varied and on average have been very weak (if slightly positive) over the last twenty years. Typically when rising yields reflect improving growth conditions and or rising risk appetite equities have naturally benefitted. Certainly since 2010 for the most part higher yields were accompanied by higher equity prices. Track record mixed for stocks following bond yield spike. Does an exceptionally sharp back up in bond yields represent a downside risk for equities? The historical evidence is inconclusive. We looked at equity market returns in the months following 2.5SD moves in German bond yields (based on a comparison of rolling 3-month yield changes to the 52-week average). The recent spike in German yields peaked at +2.9SD on the same basis. We found 11 comparable episodes since 1980. Equity market returns subsequent to the peak rate of change in bunds were moderately positive — a median Bankof America Merrill Lynch European Equity Strategy |O1 December 2016 17 HOUSE_OVERSIGHT_014476