“By hamstringing the ability of French governments to act in the interests of the French people – or, to put it more realistically, by giving them an excuse for not so acting – that embrace has destroyed political legitimacy in France. It has contributed to a contempt for democratic politics so profound, among both rulers and ruled, that the survival of the Fifth Republic may be brought into doubt in the next few years, ‘Europe’ or no ‘Europe’.”
– Excerpt from The Rotten Heart of Europe: Dirty War for Europe’s Money by Bernard Connolly
“How can you govern a country which has 246 varieties of cheese?” – Charles de Gaulle
In medieval France, there was a legislative and consultative institution, known as the Estates-General (French: États généraux), which gathered representatives from different classes of people across the land to advise on matters of national importance. When the representatives congregated in 1614 in Paris at the occasion of the uprising being organised by Louis II de Bourbon, the prince of Condé, they complained about corruption and high levels of taxation while still maintaining allegiance to the crown. The Estates-General did not reconvene again till 1789 when it was summoned by King Louis XVI. This time, however, the representatives did not merely complain but rather provoked the French Revolution.
Political change takes times. Yet Emmanuel Macron, in only 8 months since taking office and on the back of a large parliamentary majority, has been successful in effecting meaningful change in France. Most notable of all of Macron’s achievements to date is the signing of five decrees in September last year to reform France’s labour law. The implications of these decrees include:
- Streamlining social dialogue
When a company hires its fiftieth employee in France, it must comply with a long list of requirements, notably the nomination of workers’ representatives and the setting up of a works council and a health and safety committee. Under the reforms, the three employee representation bodies – the staff delegates (“délégués du personnel”), the Works Council (“Comité d’entreprise”) and the Health and Safety Committee (“CHSCT”) – will be merged into one single entity, called the Social and Economic Committee (“SEC”). Companies must set the SEC up by no later than 1st January, 2020.
The merger of the three bodies will reduce administrative costs and cut through significant amounts of red tape faced by large companies.
- Decentralisation of collective bargaining
Collective bargaining was generalised by law in France in 1950. This law established collective bargaining at the industry level as it was seen as the only way in which small companies could benefit from collective agreements. The introduction of the “Auroux laws” in 1982 imposed an added obligation on companies that have a trade union delegate amongst their staff – loosely companies with 50 or more employees – to negotiate pay and working hours annually – failure to do so could result in penalties.
Under Macron’s reforms, employers, in companies of less than 11 employees, will have the freedom to negotiate directly with their employees, on all topics open to collective bargaining, at company-level instead of industry-level. Agreement of terms between the employer and employees is subject to ratification by a majority of two-thirds of the employees. This new ratification method is also applicable to companies of 11 to 20 employees that do not have a trade union delegate.
The reforms also increase flexibility for businesses with 21 to 49 employees and no trade union delegate by allowing them to negotiate agreements with elected, but not unionised, employees.
Given that over 90 per cent of French companies have fewer than 50 employees and no trade union delegates, the decentralisation of collective bargaining is a major win for business. Companies are now less susceptible to being held hostage by powerful labour unions such as the General Confederation of Labour (CGT).
- Settlements for unfair dismissal
Firing employees in France has always been both challenging and costly. Up until the recent reforms, employees in France could obtain huge settlements for unfair dismissal and could make claims against their dismissal up to two years after the fact. Now, however, damages will fall within a set floor and ceiling and workers will now have twelve months to lodge their application with the tribunal for compensation for wrongful dismissal.
Damages for employees with two years of services are capped at three months’ salary with compensation increasing by a month’s salary for each year of additional service up to ten years. After ten years’ service, the annual increments are reduced to half a month’s salary. The maximum compensation is set at 20 months’ salary.
- Local not global profitability to assess case for lay off
In France, any plan to layoff multiple workers must be approved by a chamber of commerce. Judges have been known to block lay off plans or penalise companies by referencing the profitability of their global operations. This oddity, too, has been removed. Judges will now only be able to base their decisions on a lay off plan on the profitability of a company’s local operations. This is a major shift as global profitability has been the central issue over company shutdowns and restructurings in France over the years, most notably in ArcelorMittal’s attempt to lay off workers at Florange steelworks in 2013.
These labour reforms are certainly good for business. Administrative costs will be lower, transparency on potential damages arising from layoffs is higher, and multinationals will not be unduly penalised for the performance of their international operations. Employees, however, should also benefit. Companies will now be more willing to hire in good times as they know they will be able to shed staff, without onerous levels of red tape, in bad times. While wage gains will be limited as the combination of employers now having more flexibility in negotiating terms and the high unemployment levels in France give businesses a stronger hand, unemployment should decline.
France’s first budget under Macron, while not without its critics, is also another early success. The budget reduced the scope of the wealth tax to real estate assets and put in place a flat 30 per cent levy on capital gains, replacing the previous progressive tax on capital gains that went as high as 45 per cent. The corporate tax rate has been cut to 30 per cent starting 2018 and will be reduced to 28 per cent on 1 January 2020, 26.5 per cent on 1 January 2021 and 25 per cent on 1 January 2022. Until 1 January 2020, the corporate tax rate will remain 30 per cent.
The early reforms achieved by the Macron government should boost the domestic profitability of French companies over the coming 2 to 3 years; while at the same time strengthening the case for capital investment into France. Moreover, the reforms come at a time when Europe, collectively, is in a cyclical upturn. Thus enabling the French economy to both contribute to and benefit from this upturn.
Europe’s cyclical upturn is real and it is broad based. Industrial production, excluding construction, is picking up across the Eurozone.
Eurozone Industrial Production Ex-Construction YoY
Source: Bloomberg
If we look across some of the major European economies, the industrial production trends are similar.
Industrial Production Ex-Construction YoY for Major EU Economies 
Source: Bloomberg
Construction activity too is starting to pick up. Using the number of residential construction permits issued as a proxy; we can see that construction activity is witnessing a strong pick up in France and Spain.
OECD Construction Orders Permits – Residential Buildings Indices
Source: Bloomberg
Unemployment is declining as a result of the higher levels of economic activity.
Eurozone Unemployment Rate (%)
Source: Bloomberg
This is translating into improving consumer confidence.
European Commission Consumer Confidence Indicator
Source: Bloomberg
Business appetite for borrowing has also picked up with a strengthening economy.
European Central Bank Money Supply M2 YoY
Source: European Central Bank
Given the still high levels of unemployment in the Eurozone and relatively frictionless labour mobility, nominal wage growth remains subdued and is likely to remain so until the labour market tightens significantly. And this, we think, will keep the ECB from tightening too quickly and instead allow monetary policy to remain accommodative for at least another 18 to 24 months, which should be supportive of profitability of Eurozone companies.
Investment Perspective
A strengthening Euro has thus far not derailed the recovery in the Eurozone. This is because the recovery is domestically driven and not by exports or as a consequence of an undervalued currency. The ECB’s accommodative policies have kept the cost of capital low, allowing companies to repair their balance sheets and increase profitability.
Comparing the price performance of the STOXX Europe Mid 200 Index – a representative index for mid-cap companies in Europe – to the trailing twelve months price-to-earnings ratio of the index, we find that over the last two years earnings growth, not multiple expansion, has driven the price performance of mid-cap European companies. In fact, the price-to-earnings ratio has contracted over the last two years by over 25 per cent while the index is up over 16 per cent.
STOXX Europe Mid 200 Price Index – Price vs. Price-to-Earnings Ratio
Source: Bloomberg
We prefer small- and mid-cap exposure in Europe over broad based equities exposure. We think a stronger Euro will be a headwind for many large-companies as most of them have a significant portion of their earnings coming from exports.
At a sector level in the mid-cap space, we like automobiles and components producers, consumer services companies, mid-sized Spanish banks, and insurance companies. Areas that we would avoid include food & beverage producers and distributors, media companies and mid-sized energy related plays.
* Note if you would like to discuss specific names please email us
This post should not be considered as investment advice or a recommendation to purchase any particular security, strategy or investment product. References to specific securities and issuers are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.