Beware The Franco-German Spread

Rawf8/iStock via Getty Images Elections for the EU parliament are sending shock waves throughout financial markets in Europe. The national elections still matter more, when it comes to the politics of large EU countries, but the dismal performance of French President Emmanual Macron’s party caused him to call a snap election in France next month. This is an election Macron’s party is likely to lose. In France, the National Rally (a party similar to the right wing “Alternative for Germany”) came in first, gathering 31.4% of the votes. And if Germany’s Chancellor Olaf Scholz called for a snap election there, too, he wouldn’t be Chancellor for long. Scholz’s party came in third behind the right-wing Alternative for Germany and the Christian Democrats (Angela Merkel’s party), which got 30% of the votes. Europe has made a hard turn to the right, where the parties that are coming up from small bases are broadly described as “Eurosceptics.” Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary. This expectation of a French veto of Monsieur Macron’s party is causing investors to buy German bunds and sell French government bonds, causing an expansion of the classic “Franco-German spread.” The more this spread increases, the more pressure on the equivalent stock benchmarks in Europe will become. Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary. If this selling in Europe continues, it is likely to rub off negatively on U.S. stocks. One could argue that the S&P 500 is in need of a pullback and the political turmoil in Europe may be a good excuse to get one. All this is happening as the S&P 500 and NASDAQ 100 are at or near all-time highs, while the German DAX index is closer to its April lows than its May highs. Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary. There is another matter that concerns me. We seem to finally be seeing a turn in Treasury yields. The 10-year closed Friday at 4.21%, which is much lower than its April high of 4.74%, yet the broad market is not responding positively. It used to be that lower bond yields meant broader stock market participation, but this is not really happening now. Having a narrow stock market rally is not a reason for the stock market to immediately start going down, as it can last for a while, but it is a little disconcerting that we are seeing broadening weakness in U.S. stock sectors while the rally is more or less concentrated in the technology sector. Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary. We finally got a surge in weekly jobless claims, rising to 240,000 last week (see graph, above). This is the highest reading of the year. The highest reading in 2023 was 261,000 last summer. If weekly jobless claims rise above 261K and stay there, one could make a credible case that the job market is weakening, which would explain why the broad market is not rallying as the 10-year yield is off by more than 50 basis points from its April high. Watch this measure closely, since weekly jobless claims will have a bigger impact on equities and bonds this week, particularly if they come in higher than last week. It appears to me that the Fed got its decline in inflation and if it were not for the owners’ equivalent rent, inflation numbers would be much lower now, similar to Europe’s, which has already caused the ECB to cut rates. Since both inflation and employment are lagging indicators, Fed chair Jerome Powell would be making a very big mistake if the economy weakens notably in the next three months. This is not a prediction but my statement of a clear possibility, while Powell is stubbornly stuck in restrictive territory. All content above represents the opinion of Ivan Martchev of Navellier & Associates, Inc. Disclaimer: Please click here for important disclosures located in the “About” section of the Navellier & Associates profile that accompany this article. Disclosure: *Navellier may hold securities in one or more investment strategies offered to its clients. Original Post Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.

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