In Scope:

Markets rattled by Italian political turmoil

May 29, 2018
 

Despite failing to qualify for the World Cup, Italy sure has made the headlines, albeit with yet another political crisis. News like this normally receives little to no international exposure, but the possibility of Italy leaving the euro –a topic of heated debate – has struck a nerve in the financial markets.

 

The Facts

  • Following the fractured results of the general election in March, populist parties Lega and the Five Star Movement (5S) reached a coalition agreement after lengthy negotiations. However, President Matarella subsequently vetoed Paolo Savona’s candidacy for finance minister, as he had previously advocated Italy’s exit from the euro. This has sent Italy into complete political chaos.
 
  • The financial markets responded rather nervously:
    • The spread –which measures the yield differential between Italian and German 10-year bonds- rose to 263 basis points, its highest level since 2013.
    • The Italian stock market (the FTSE-MIB) had already fallen by 13% since early May, and bank shares dropped 15 to 25%.
    • The euro fell by roughly 6.5% against the dollar from early May.
    • Shares from the euro area declined approximately 5%.
 

So, now what?

  • Italy’s political future is highly uncertain. One possibility is the formation of a temporary technocratic government, but there is no saying whether there will be adequate support in Parliament. There is also the likelihood of new elections being held this or next year –and it remains to be seen what the outcome will be this time.

  • An Italian exit from the euro or a systemic crisis in the monetary union seem rather unlikely:
    • Italy would gain nothing from leaving the euro: both the Italian national debt and the banking system are backed by the European Central Bank. Moreover, the number of citizens and politicians truly supporting an Italian euro exit appear to be in the minority.
    • Other countries facing a similar political crisis –such as Greece and Portugal – also seemed to be heading towards a euro exit, but ended up taking the necessary measures to comply with European regulations.
    • The euro area’s recovery in recent years has reduced the risk of contagion. The deficits and debt ratios of the euro area countries have stabilised; the European Stability Mechanism can intervene with loans or rescue loans; the banking sector improved its capital ratios; and the ECB maintains its role as economic lifesaver.
 
  • A set item on the menu is sustained political uncertainty – which, of course, is par for the course in Italy. Other parts of the euro area, however, show great political stability. Large EU countries, such as Germany and France, are led by pro-European parties. Spain – where political turmoil also increased towards the end of last week –is not in favour of a euro exit.
 

Our investment strategy (*)

  • Panic is a bad counsellor. We do not expect any changes to the investment strategy in the immediate future. While we revised our overweight in equities slightly downwards (-2.5%) in mid-May, we continue to invest 2.5% above the norm, because:
    • The economic outlook remains positive, including in the euro area. Despite falling  business confidence since the turn of the year, these indicators continue to show steady growth;
    • Developments in the trade-weighted euro exchange rate have weakened the euro again, which could boost export;
    • Corporate profits continue to rise sharply;
    • Share valuations are not excessive.
 
  • Over the past few months, we reduced our overweight in the euro area within the equity markets. We will, however, continue to invest in German shares.

  • We continue to invest far below the norm in euro area government bonds, and only have limited positions in Italian debt securities.
 
 (*) The investment strategy described in this document relates to all investment funds (undertakings for collective investment) managed by KBC Asset Management NV, which make explicit reference in their investment policy, as laid out in the prospectus, to KBC Asset Management’s investment strategy. The stated strategy is not, therefore, altered in the case of other investment funds, the investment policy of which does not refer directly to KBC Asset Management’s investment strategy. It is possible that these investment funds are managed in a way that differs from the investment strategy. You should always read the prospectus and the Key Investor Information Document for the relevant investment fund.
 
This document is a publication of KBC Asset Management NV (KBC AM). The information can be changed without notice and offers no guarantee for the future. No part of this document may be reproduced without the prior, express, written consent of KBC AM. This information is governed by the laws of Belgium and is subject to the exclusive jurisdiction of its courts. Publisher: KBC Group NV, Havenlaan 2, 1080 Brussel, Belgiƫ. VAT BE 0403.227.515, RLP Brussels. www.kbc.be. A company of the KBC group.