"The Sword of Damocles" looms over France as assets continue to cool, luxury stocks may face a turning point.

French assets continue to be heavily discounted, and French Prime Minister Franois Beru's efforts to address the ongoing political crisis are far from enough to attract investors back. To change this situation, France needs to develop a concrete plan to reduce its huge budget deficit. Six months ago, French President Emmanuel Macron announced early elections, which shook French assets. The performance of the French CAC 40 index this year has lagged behind other major European benchmarks, and the cost of credit default swaps on French debt is rising. The additional yield on French bonds relative to German bonds is about 80 basis points, nearly double what it was before the elections. Meanwhile, trading activity in the French market has sharply declined since August last year. French stock market weak Vincent Juvyns, global market strategist at J.P. Morgan Asset Management, said, "The French stock market hangs a sword of Damocles." He stated that the market demands action on the deficit, "the CAC 40 and European markets urgently need to eliminate these uncertainties, promote budget reforms, and restore competitiveness." Juvyns believes that it is "highly likely" that France will hold new elections in July, and he says that given the budget situation and political deadlock, the 80 basis point spread between French and German government bonds is relatively low. He added, "Given the current situation, ultimately a 100 basis points spread is a more reasonable level." French sovereign bond risks continue to rise Beru recently announced that he aims to control the budget deficit in 2025 at 5.4% of Gross Domestic Product (GDP), slightly higher than the previous government's deficit plan, which the market welcomed. Beru plans to reduce the deficit to the EU target of 3% by 2029, but investors are clearly skeptical. Meanwhile, Beru will face a vote of no confidence later on Thursday, and his government is likely to survive this vote. With multiple votes possible in the coming weeks, Beru has been actively negotiating with various parties to avoid the same fate as his predecessor. The challenging situation in the past few months has not significantly changed the valuation of blue-chip stocks, with the expected price-earnings ratio of the CAC 40 index at 13.5 times, which is essentially the same as the long-term average level and on par with the benchmark Stoxx Europe 600 index. In contrast, a basket of stocks focusing on the French domestic economy tracked by Goldman Sachs currently has an expected price-earnings ratio of less than 8 times, the lowest level in over two years. Arnaud Girod, head of economics and cross-asset strategy at Kepler Cheuvreux, said, "Stock prices related to the French economy are too cheap, but as long as political risk is high, buying these stocks makes no sense. Luxury goods stocks dominate other sectors of the French stock market, and given the situation in the trade war, we have a neutral stance on luxury goods stocks." Investors have a similar attitude towards all French stocks. Only 15% of the revenue of the French CAC 40 index constituents comes from France, but their earnings performance has been poor. Besides French politics, the CAC 40 index may have other issues as its constituents are heavily reliant on uncertain global economic growth. Non-essential consumer goods and industrial stocks make up over 50% of the benchmark index. Luxury goods and cosmetics stocks, including LVMH, Hermes, Kering Group, and L'Oreal Group, account for about 20% of the weight of the CAC index. However, Swiss luxury goods company Richemont Group recently announced better-than-expected third-quarter sales, leading to a 14% increase in its stock price, which could be a turning point for French luxury goods stocks. Benjamin Melman, Chief Investment Officer at Edmond de Rothschild Asset Management, said, "The performance of the French stock market has been poor since the beginning of the year, and the risk discount still exists, but we expect that unless there is a new political crisis, this discount will not widen." He added, "The French government's strategy has changed compared to the previous government, which can provide some sustainability and longer political expectations. However, visibility remains low."