French stocks have taken a battering recently as numerous fundamental factors weigh on the outlook for the French economy, specifically the CAC 40 equity index. The latest decision handed down from the European Central Bank combined with the worsening global outlook presents several obstacles for the equity benchmark even though 1-year returns are still well above that of comparable global indices. The upward trending Euro will also work to stymie any upward momentum and rebound in the CAC 40 as stocks become more expensive due to the appreciation of the common currency, possibly leading to a longer than anticipated near-term selloff in the index even though longer-term prospects remain largely positive.

ECB Disappointment Leads to CAC Losses

Amid widespread speculation that the European Central Bank would opt to expand the current rate of monthly asset purchases, the French CAC 40 rallied into the latest interest rate decision and announcement regarding quantitative easing. However, the failure by the ECB to expand the pace of monthly purchases by the expected €15-20 billion from the current €60 billion was met with substantial losses across the board for European stocks and regional benchmarks. Generally speaking, there is a very strong correlation between the expansion of a central bank’s balance sheet and upward momentum in equity instruments.

When a central bank, such as the ECB, opts to loosen monetary policy and buy assets in an effort to drive down longer-term borrowing costs, the monetization process oftentimes limits the available pool of outstanding assets for investors while decreasing potential yield. This invariably leads investors on the hunt for higher yielding assets in order to attain higher returns. However, in the case of central banking and the post-crisis experience, this type of central bank strategy oftentimes channels investment straight towards the higher risk and higher reward characteristics of stocks and broader equity indices.