French Economic Reforms Improve Appeal of Cheap French Stocks

By: Money_Morning

Martin Hutchinson writes: French investments might have seemed like a bad idea for the first nine months of French President Nicolas Sarkozy's term. After his election in May 2007, Sarkozy looked like a huge disappointment - unless you REALLY enjoy tabloid stories. He divorced his wife, married the spectacularly beautiful ex-model Carla Bruni, and went on an enviable honeymoon in Egypt - but appeared to do nothing useful about France's economic problems.

But now there's some good news for French investments. Like all good Frenchmen, Sarkozy may have preferred first to concentrate on his private life when elected President de la Republique. But with his private life now settled he's been able to spare some time for France's economic problems. And the results for France's future economic performance and French investments are quite positive.

First, Sarkozy got rid of the 35-hour week. This economy-destroying measure, by which companies were forced to institute a maximum 35-hour workweek, was brought in by the Socialists in 2000, and has embedded itself throughout the French economy, increasing labor costs, reducing productivity and harming French investments. Removing it will not make much difference for big business - as one union leader said “nobody wants to renegotiate the 35 hours and reopen Pandora's box” but it will make a huge difference for medium-sized and smaller businesses, which will be able to match their workforce with the demands of their business, without being forced into a straitjacket by the state.

Sarkozy has also passed reforms freeing up France's retail sector to increased competition with longer operating hours, tighter regulation of unemployment benefits, and freedom for firms to negotiate directly with employees rather than deal with a union.

In addition to these economic reforms, Sarkozy has pushed through constitutional reforms, limiting the president to two five-year terms and giving the legislature more power to introduce legislation.

The remarkable feature of Sarkozy's burst of reformism is that the French unions have been unable to tie up the streets of Paris with major demonstrations, as they had done to stall several previous bursts of reformism in the last decade. A Day of Action protest in June had only half the expected turnout and a nationwide strike had only 4% support.

Sarkozy's tactic has been to move forward with reforms on several fronts at once; this seems to have worked, and Sarkozy's opinion poll numbers have recovered from lows hit in early spring.

The benefits of these reforms will be seen most clearly in France's next period of economic expansion, which may not be immediate because of the general global slowdown. France's gross domestic product (GDP) is expected to increase only 1.7% in 2008, according to the Economist , the same as the average for the 15-nation Eurozone as a whole .

On the bright side, inflation is expected to be only 3.2%, below the Eurozone average and well below U.S. inflation rates. The balance of payments deficit is only 1.6% of GDP, well below both the United States and Britain, in spite of the current high valuation of the euro. Euro short-term interest rates are currently 4.25%, above France's inflation level, and French long-term government bonds yield 4.8%, well above inflation, so there is little danger of an inflationary spiral.

French Investments to Fatten Your Portfolio

A further advantage of the French stock market is that it is currently cheap, trading at only 11.5 times earnings. The CAC-40 index is down about 25% this year, similar to the performance of the Dow Jones Industrial Average Index , but it had risen nowhere near as far between 2003 and 2007, and is still 30% below its 2000 high. With France's economic and political prospects looking brighter than they have in a long time, French investments could be an attractive part of your portfolio.

First, you can buy the index. The iShares MSCI France Index ( EWQ ) is an exchange-traded fund (ETF) with a value of $266 million, sufficient for liquidity, that is currently trading at the French market's Price/Earnings (P/E) ratio of 11.4, well below the S&P500 Index P/E ratio of 14.6. Because France is unlikely to suffer a deep recession and isn't playing host to enormous write-offs in its financial sector, it is reasonable to expect that the index would trade at a premium to the S&P 500, so that's already a bargain.

Attractively, EWQ also carries a 4.9% yield, denominated in euros, giving income investors an attractive diversification from the U.S. market, which even after its recent drop yields only 1.7% on the S&P 500.

Second, you might consider France Telecom SA (ADR: FTE ) which operates both fixed and mobile telephone systems in France, Britain, Spain and Poland - almost all of its operations in Europe, therefore, without significant exports to the dollar zone. France Telecom is very reasonably priced at 8 times trailing earnings. Even more attractive, it has a dividend yield of 6.2%, again denominated in euros - it thus represents an ideal investment for income-oriented investors.

Investors wanting a stock with recovery potential might consider AXA (ADR: AXA ), a huge insurance company and asset manager based in France but with substantial operations worldwide. Because of the battering taken by financial services companies, AXA currently trades at only 6.5 times earnings, with a 7% yield. The one caveat is that insurance companies are given a lot of flexibility when “marking to market” their investments; it's therefore possible that AXA has a large exposure to the U.S. subprime market or some other disaster that it hasn't owned up to. However, the stock's low rating and high dividend certainly compensate you well for this risk.

Finally, there's a somewhat higher rating at 13 times earnings (but alas, with no dividend) for France's largest geophysical company CGG Veritas (ADR: CGV ). CGV provides geophysical services to the oil and gas industry worldwide, and manufactures land, marine, and subsea data acquisition equipment. Needless to say, business at CGV is booming, so the forward P/E ratio is only 9.38.

As I said, French investments seem well worthwhile for a substantial chunk of your money.

News and Related Story Links:

• Money Morning: Eurozone Growth Revised Down as Inflationary Pressures Trump Economic Growth
• Money Morning: Escalating Inflation at Home and Abroad Puts Pressure on Central Bankers

By Martin Hutchinson
Contributing Editor

Money Morning/The Money Map Report

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