It's Time to Buy European Stocks -- Sorta, Kinda, Maybe

By James Mackintosh Features Dow Jones Newswires

There is a tendency for British and American investors to look down their noses at France. The bureaucracy, 35-hour workweek, aggressive trade unions, pushy farmers and protection of national champions -- even in yogurt -- attract derision, and the country is often held up as among Europe's most resistant to change.

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France has problems, part of the reason for one third of votes for president going to far-right nationalist Marine Le Pen at the weekend.

But France has a lot going for it economically. It is rich, educated and highly productive. Output per person is the same as in the U.K. (adjusted for purchasing power), despite having an unemployment rate more than twice as high. Workers in France are far more productive, allowing them both to work less and produce more than British workers.

Those who laugh at the 35-hour week tend to forget both that it is only the basis before paid overtime kicks in, and that the average worked in the U.S. is even lower, with last week's nonfarm-payrolls report showing private workers put in 34.4 hours.

Even French growth hasn't been that bad. Since 1980, Thatcherite reforms have given Britain the fastest growth in output per head of the Group of Seven leading industrialized nations, but from 1980 to 2006 France grew almost exactly in line with Germany, Italy and Canada. Since then, Italy has become poorer, Germany a lot richer, while France and Canada have both put in slow growth.

France needs reform. Her young people are frustrated, with pre-election polls showing far more support for Ms. Le Pen among youth than among older voters -- a demographic reversal of the Brexit and Donald Trump votes with which her populist National Front is often grouped. The labor market needs shaking up so it can create more jobs for young workers. Corporate taxes are high, too, deterring both job creation and entrepreneurs. But France is hardly the only country with that problem.

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Newly elected President Emmanuel Macron is acutely aware of the challenge, but still needs to win a mandate for reform in parliamentary elections next month. The presidential election was fought mainly as a battle between an inward-looking nationalist viewpoint and an outward-looking embrace of Europe.

For investors, Mr. Macron's victory matters mostly because of who he isn't. For the next five years, there is no risk of France quitting the euro, taking away much of the risk priced into French bonds in the buildup to the election.

Mr. Macron's plans for mild reforms in France are hard to get excited about, even if they survive the traditional French test of violent street protests. More relevant now is that investors can stop worrying about "Frexit," a French exit from the euro, and focus on the European economy.

The eurozone economy has grown a little faster than the U.S. since the end of 2014, and in the first quarter expanded twice as fast. Unemployment is still high, at 9.5%, but it is the lowest in eight years. Equally, core inflation is still only 1.2%, but is the closest it has been to the European Central Bank's 2% target in four years. Even as the U.S. has lost momentum, European data continues to beat forecasts at close to the highest rate since the first Greek bailout in 2010, according to Citigroup's economic surprise index.

The ECB remains dovish, but it is widely expected soon to signal a retreat from its controversial policies of buying bonds and holding interest rates below zero. Investors appear finally to have accepted that European growth has taken hold, so a move away from negative rates should help bank stocks, and do little harm to other equities.

However good the data, it is hard to get truly excited about Europe. Investors have been hit too many times by political ructions and surprise bank failures in the past seven years to be entirely calm. Italy's populist 5 Star Movement is neck and neck with the ruling Democratic party, so the Italian election next year will test nerves.

Outside the banks, stocks aren't particularly cheap, either. French stocks are up 10.7% this year even after a pullback on Monday, or 16% in dollar terms, compared with a 7.2% gain for the S&P 500.

Mr. Macron's victory is good news for investors, Europe is recovering perfectly well and investors ought to have some exposure to the region. Like Mr. Macron's voters, it is hard to be any more enthusiastic.

Write to James Mackintosh at James.Mackintosh@wsj.com

(END) Dow Jones Newswires

May 08, 2017 10:45 ET (14:45 GMT)