And Then There Were Two

French voters went to the polls Sunday, and as expected, they didn't pick a president. They did, however, narrow the field from seven to two, resolving much of the uncertainty surrounding the contest. Markets welcomed the added clarity, opening Monday sharply higher. France's CAC 40 soared 4.1%.^[i] Germany (3.4%), Italy (4.8%), Spain (3.8%) and the rest of Europe rallied, too.^[ii] Even though we still don't know the ultimate winner, and even though anti-euro Marine Le Pen made it to the runoff, narrowing the field helps markets form probabilities and assess the likelihood of France's next president pulling the country out of the eurozone. That clarity is enough, and it's a microcosm of what investors should expect from eurozone stocks in what we expect to be a year of falling uncertainty.

Pre-election uncertainty weighed on French and European stocks in recent weeks-particularly as leftist candidate Jean-Luc Mélenchon surged in the polls in April, fueling fears that the final round would pit him against Le Pen, guaranteeing France's next president would be an anti-euro outsider. Before the election, French stocks had lagged eurozone stocks most of the year, and both France and eurozone stocks slid from March 28 through the election.

Exhibit 1: French and Eurozone Stocks Pre-Election

Source: FactSet, as of 4/24/2017. MSCI France and MSCI EMU returns with net dividends, in USD, 12/31/2016 - 4/21/2017. Indexed to 100 on 12/31/2016.

Even though we don't yet know who France's next president will be, many of the questions that weighed on French stocks before the vote are answered now. Independent centrist Emmanuel Macron won the most votes-23.9%, edging Le Pen's 21.4%-erasing concerns about Mélenchon. Scandal-plagued FranÇois Fillon, candidate for Les Republicains (the center-right party of former president Nicolas Sarkozy) didn't advance, erasing concerns about a relatively weaker pro-euro candidate facing Le Pen in the runoff. Macron's 2.5-point margin over Le Pen eased concerns over polls' accuracy, as the last few surveys showed him about that far ahead of her. This should give investors even more confidence for the second round, where polls have long given Macron a 20 to 25-point edge over Le Pen. Not that his final victory is a foregone conclusion-if Mélenchon's supporters flock to Le Pen while those who supported Fillon or the Socialists' Benoît Hamon stay home, anything could happen.

But markets don't move on possibilities. They move on probabilities. Before Sunday's vote, it was difficult to assess probabilities for the May 7 runoff, because the polls were so tight, and Friday's tragic terrorist attack added an unfortunate wild card. Mélenchon, Fillon, Le Pen and Macron all had decent shots of making the final round. There were too many permutations. It created a fog of fear and what-ifs, which markets generally dislike. They're happier when the fog is gone and they can focus on the future, able to form reasonable expectations. We saw this in the Netherlands in March, when Dutch stocks rallied as it became clear the country's next government would be a fractured-but pro-euro-coalition, and now we're seeing it in France.

This isn't markets' last chance to benefit from falling European uncertainty-there are plenty more political dominoes to fall, starting with France's May 7 runoff. The UK holds a snap election on June 8. Then France votes again, this time for parliamentary elections, on June 11 and June 18 (a two-part contest, like the presidential vote). Germany rounds out the pack with its federal election in September. At each turn, more fog will clear, helping investors better see Europe's bright economic fundamentals and gain more and more confidence in stocks' future prospects. Eurozone stocks should ride this powerful falling-uncertainty tailwind for the foreseeable future.