29 MAY

2018

Where do we stand?

  1. What’s new on the economy?

    The short-term outlook has improved. Italy's recovery has strengthened and labor market conditions have turned more favorable although the unemployment rate remains elevated. This has contributed to higher consumer confidence. Recent business surveys and indicators were in line with Italian GDP growing by close to 1.5% in 2018.

    Most of the deeply rooted longer-term issues however have not been tackled. Structural weaknesses are weighing on Italy’s growth potential: productivity growth is awfully weak and the demographic remains challenging. Growing regional disparities, elevated long-term and youth unemployment as well as a rising relative poverty rate remain risks for social cohesion and growth. Moreover, despite a primary surplus, Italy’s public debt is elevated… and not yet on a sustainable path.  

  2. What’s new on the political scene?

    (update – 1 June)

    After 3 months of incertitude, Italy has a new government headed by Giuseppe Conte, a law professor and a novice in politics. The key post of finance minister which had previously caused the president to use his veto at the start of the week has finally gone to Giovanni Tria, a less controversial choice than Paolo Savona. Although the newly-appointed finance minister does not envisage leaving the eurozone, he is nonetheless highly critical of EU economic governance.

    We believe that this government is highly unlikely to implement the full range of tax cuts and spending increases included in the programme apparently agreed by the M5S / L coalition, which would weigh approximately 6% on the GDP budgetary balance. There is still a very real risk of a clash with Europe however, on both budgetary [1] and immigration issues.

    Although the markets appear to have reacted positively to the announcement of the formation of a new government, this does not mean that political instability in Italy has abated however. The M5S / L coalition is a purely circumstantial tie-up which remains fragile. Against this backdrop, the markets will adjust in real-time to changes in the political situation in Italy, which will impact volatility in the euro exchange rate and among Southern European sovereign spreads … and also the pace of monetary tightening by the ECB.

 

What about our market positioning on Italian assets?

Italian bonds 

Our view on Italian sovereign bonds was and remains cautious. Our long-held negative assessment of Italy’s debt is driven by their weak economic growth dynamics and their vulnerable debt sustainability.

In our active funds, we are underweight Italian bonds versus the benchmark.

With the ongoing Euroskeptic rhetoric and potential  fiscal slippage, we believe the current high risk premium and volatility on Italian bonds is likely to remain.

A partial implementation of the draft program of the MS5 and League regarding fiscal policy could indeed lead to a sizeable increase in the government deficit and public debt. This also would bring the risk of sovereign credit downgrades back to the forefront.

 

Italian equities

Our view on Italian equities was and remains cautious. We expect volatility ahead while performance will remain closely linked to political news flow.  

Besides the political turmoil, Italian equities will also be penalized by the stock market index’s high concentration on 3 sectors and its domestic exposure, which lies at the mercy of the country’s economic activity.

Financials, energy and utilities account for 72% of the MSCI Italy and the forecast is not too optimistic for any of them in the short term.

We expect the earnings growth of financials and banks in general to suffer. It is also unlikely that the energy sector will find any relief if oil prices continue to back down from the 80-USD range a barrel.



[1] The President has the power to veto the Budget using Article 81 of the Italian Constitution, which introduces a “balanced budget principle”, and Article 97, which states that “general government entities, in accordance with EU law, shall ensure balanced budgets and the sustainability of public debt”.