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Politics Brings Volatility to Italian Asset Prices
WHAT HAS HAPPENED?
Italian asset prices experienced a turbulent time in May. The yield on the Italian 10-year government bond jumped by more than 150bps to a high of 3.16% during the month, the highest it has been since the depths of the eurozone crisis. Meanwhile the benchmark Italian stock market, the FTSE MIB fell sharply, with Italian banks amongst the hardest hit.
WHY?
The declines in Italian asset prices came as political risks rose in the country. March’s general election provided no clear winner and chances appeared low that a coalition would be able to be formed between any of the major parties due to the dispersion of ideologies. However, in May, the Five Star Movement and the League, both populist parties but from opposing sides of the political spectrum, announced that they had reached an agreement to attempt to form a coalition government. While this was met with some trepidation in financial markets, including ratings agency Moody’s who placed the country’s credit rating on review for a downgrade, many noted that, with just 50.1% of the electorate’s support, it would be a weak coalition that would struggle to implement its desired reforms. In order to form a government, the alliance would need approval from the country’s President and when he rejected its euro-sceptic nominee for finance minister Italy looked set to return to the polls later this year. Early opinion polls suggesting a surge in support for populist parties and the League in particular, led to a sharp decline in Italian assets on fears that an election might provide a stronger mandate to parties which have questioned the benefits of Italy’s euro membership. Most recently, however, the League agreed to replace its candidate and the President approved the new choice. A new government led by Giuseppe Conte is set to be sworn in today.
WHAT SHOULD YOU TAKE AWAY FROM IT?
The last month has shown not just how difficult it is to predict the outcome of political events but also how difficult it is to predict the markets’ reaction to them. What was initially considered a negative outcome of the Italian election quickly became the lesser of two evils, as Italian asset prices rallied on the prospect of a coalition government being sworn in later today. Political risks are never far from the surface and aside from Italy, the uncertainties surrounding Brexit, the unpredictability of US President Donald Trump and tensions in the Middle East are all likely to influence financial markets going forward.
At Killik & Co, while we keep a keen eye on the political backdrop, we are cognisant of the difficulties in predicting political outcomes and therefore place significant importance on diversification not just by asset class but by geography. Exposure to a diverse range of companies with exposures to different regions can reduce the amount of political risk within a portfolio. Please speak to your Investment Manager for more information.
