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Blog Posts — December 11, 2018

Plenty of Yellow Vests, but Few Yellow Flags

by Melissa R. Brown, CFA

The recent Yellow Vest protests in France are a particularly striking example of the search for alternative political solutions in many countries around the world. France’s Finance Minister Bruno Le Maire believes the recent protests will have a severe impact on the French economy—but that remains to be seen. Even before the increase in violence over the last few days, equity market participants signaled their concerns, driving French stocks down about 12% (in euros) since the end of September. To be sure, developed-market stocks across Europe have tanked as well, but France has sharply lagged the European market (as measured by the FTSE Developed Europe index) over the past few months. Of course, this type of protest may spread to other countries, adding insult to the injury already being felt by the uncertainty surrounding Brexit, trade wars, inflation fears, central bank tightening, etc., but that also suggests France’s equity performance could be followed by even worse returns in other European countries.

With France’s recent underperformance in mind, we looked at its risk from a number of different perspectives: Total risk, “country” risk (risk over and above that of the other factors), and how much of the total benchmark risk is commanded by France, along with how that compares with France’s benchmark weight. Our conclusion is that despite lagging the market very recently, France does not stand out dramatically versus the rest of Europe from a risk perspective, most likely because many other countries have their own issues.

While the total risk of a capitalization-weighted portfolio of French stocks has increased sharply—up about 65% since the end of September—total risk for a portfolio of European stocks has risen even more, roughly 72%. Until the last few days, the risk of France relative to that of Europe had actually been falling. This suggests that some of the other headline issues in European countries—perhaps Brexit negotiations, German political uncertainty, Italian budget issue, or other areas of concern—may actually be viewed as having longer-term implications.

Next, we looked at risk of a few “country factors” in the short-horizon European fundamental (EU4) model. This factor measures the country’s risk over and above that of all the other factors in the risk model, and can be thought of risk that is unique to that particular country. From this vantage point, risk of making an active bet in France (versus a FTSE Developed Europe benchmark) has indeed increased, and so has a bet on the UK. Germany’s country risk, in contrast, has remained fairly stable over the same time period, after climbing earlier this year. Italy has seen its country risk decline, but still has substantially higher risk than the other countries (and hence is shown in a different chart).

Finally, we calculated the capitalization weight of France within the FTSE Developed Europe benchmark, along with its contribution to risk. At the end of each of the past 12 months, as well as last Friday, France has maintained a fairly steady representation in the index of between 16 and 17%. Its contribution to the overall risk of the benchmark, however, has exceeded its weight by between about 1 and 2 percentage points since August, but that difference is relatively small. (As a point of contrast, the US’s contribution to risk of the FTSE Developed benchmark is about three percentage points higher than its weight).

The bottom line is, while the Yellow Vest protests have pulled France into the daily news cycle, they do not seem to have had a material impact on France’s volatility versus the rest of Europe. Of course, the sharp increase in risk for the region reflects the ongoing concerns (and in some cases turmoil) in a number of European countries, but so far France does not seem to represent a substantially higher level of risk—at least compared with recent times.