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Investment views

Podcast: Sharp focus on Italy

31 May 2018

John Stopford looks at the recent political turmoil in Italy and whether he sees Italy leaving the European Union



Lindsay Williams: As always on a Tuesday, it’s the Investec Asset Management-sponsored Big Picture and the big picture is a big picture in Europe. It’s the third biggest picture because the Italian economy is the third biggest in the Eurozone and it has come sharply into focus recently.On the telephone now to tell us why is John Stopford, Head of Multi-Asset Income at Investec Asset Management in London. John, over the last few days, Italy has suddenly come sharply into focus, not because of not being in the World Cup but because of political reasons. It’s a fascinating story!

John Stopford: Yes, indeed. So the Italians had an election a few months ago. Populist parties basically got the larger share of the vote. There was some question about whether the two main populist parties that are sort of left leaning and to the right could get together. They managed to get together.

They started to form a government and then Italy has this sort of constitutional arrangement where the President can block things if he thinks that they are against the interests of the country. He blocked the forming of the government because he wouldn’t allow them to appoint the finance minister they wanted. They want to pursue a very populist agenda – tax cuts, more spending. Italy is heading to be completely at odds with, you know, ultimately the sustainability of Italy within the Eurozone.

Lindsay Williams: Tense situation which no one thought could happen. People are saying well, it’s the end of May and it’s the holidays in Northern Europe and Southern Europe as well and this is just something that is a nice distraction for Bloomberg and CNBC and other radio and television stations but do you think that there is any foundation to this?  Do you think this is a chance for the Eurozone to start to unravel post-Brexit?

John Stopford: I’m not sure it is immediate and Italy I think is more embedded in Europe than the UK ever has been and I think Italians generally regard themselves as European. The problem is that the solutions that Italy has generally pursued when it has had economic difficulties no longer exist within the Eurozone. So typically Italy would devalue the lira to regain competitiveness and that would boost growth and so on. They have been living in a sort of world without growth now for most of the last 20 years. Their debt level remains unsustainable in the medium term.  The Italian economy is probably pretty uncompetitive relative to its northern trading parties within Europe and Italians are getting a bit sick of it.

So I think this definitely could be the beginning of the end and the parties involved trying to put the coalition together are inherently more Euro-sceptic. They are sort of populist and less mainstream. They have raised the possibility of parallel currencies.  They have raised the possibility of exit. They didn’t explicitly campaign on that basis. If anything, they toned down their rhetoric but their policy platform is at odds with the direction that France definitely wants to go in, that Germany wants to go in and so on.  And so, you know, it is not obvious what the solution is and how, on a sort of 5-year view or a 10-year view, Italian membership of the Eurozone is compatible with the needs and desires of the Italian electorate.

Lindsay Williams: The market reaction has been quite marked and it has been over a period where there have been a couple of holidays, both in the United States and the UK and also therefore the Eurozone, and therefore there has been a little bit of illiquidity and maybe an unusual movement to the upside or the downside.  Do you think that the markets are correct in what they have done today, for example, which has been asset classes getting – certainly risky asset classes, both bonds and equities, coming under pressure?  Do you think that is justified?

John Stopford: Well, I mean it clearly raises the uncertainty around the Eurozone and around growth in Europe and it pushes up risk premia and so on. I am not sure it has been that dramatic yet. I mean if you look at – yes, Italian equities are down quite a lot but they are still up a lot over the last sort of 12-18 months.  If you look at the yield that Italian bonds are paying over German government bonds, it’s sort of well off the highs that we saw ahead of Mario Draghi’s “I’ll do what it takes” speech of sort of 2011/2012. So Italian bonds, they are paying a pretty hefty premium (2.5% at 10 years) over German government bonds but they were paying more like 5.5, 6% back in 2011/2012.

So we haven’t quite reached that sort of crisis sense yet but I think people are pretty nervous and I think this is something that is not going to go away quickly. So the Italian President’s action means that, you know, this political crisis isn’t going to get resolved quickly and actually, if it does get resolved, it might be resolved in a more negative way post another election.  So, unfortunately, it is going to be around for a while.  Markets might get bored of it (I mean they do tend to) if things don’t really change but, longer term, it does look challenging for Italy within the Euro area, particularly next time we hit a recession and, you know, growth takes a general turn for the worst.

Lindsay Williams: So you think that the fact is that we are going to get a recession maybe in the next 18 months or so.   You’re willing to wait that long to say that it could become problematic.  As Head of Multi-Asset Income at Investec Asset Management, what are you doing now?  You’re not waiting for that recession, of course.

John Stopford: No, of course, we’re not and the recession – you know, the only reason I mention recession is Italy has been bumbling along, with the rest of Europe expanding.  You know, a bit of growth helps ease the pressure a bit.  What is not clear to me is, you know, the ECB is yet to raise interest rates.  It is still printing money.  It hasn’t really got a lot of shots in the locker if Europe has a big downturn.  In those circumstances, the sort of fall-back mechanism to support spreads in Europe, the ESM, is limited in capacity.  You know, Germany doesn’t want to bail out Italy, France probably doesn’t and so on.  So it is not obvious if things get materially worse how they get out of this, particularly if Draghi is leaving or ends his term next year.  The future looks a bit troubling on that basis.

I mean what are we doing?  We are tending to run light positions or even slightly more short positions in the euro against other major European currencies, so things like the Swiss franc, sterling, Swedish krona, Norwegian krone and so on.  We are tending to avoid European bonds full stop and have essentially actually a small short position there and we are pretty circumspect again about sort of peripheral exposure, including equities.  So the beauty we have is we have a global mandate so we can look at all markets and focus on the ones where this isn’t such a direct impact, look for the opportunities there and not have to play where the environment is just massively driven by politics and uncertainty.

Lindsay Williams: But, on the other hand, you are, it sounds to me, fairly cautious about the future and you are going to more exotic asset classes and more exotic insurance policies.

John Stopford: Well, not really.  I mean we are going to places like Australia and the US and Sweden and whatever.  It is not necessarily about going to the nutty fringe.  It is about actually identifying – you know, the developed world is much bigger than Italy and it is much bigger even than core Europe or Europe and, even within Europe, there are some interesting, I think, areas to invest.

Yes, I mean emerging markets also have some interesting opportunities potentially although, clearly, they are struggling with a stronger dollar. They are struggling with, you know, concerns about policy change and tightening dollar liquidity. So we are not rushing in there at all. We are maybe looking selectively for opportunities but we don’t have to play in Italy so why do it?  I mean it is, you know, too much of a coin toss at the moment for us.

Lindsay Williams: If you were a punter and let’s talk about it in a horse-racing terminology now and you had to have a trifecta – emerging markets, Eurozone and US markets, all at very, I would say, pivotal moments in their lives – would you be going for that trifecta?

John Stopford: Not really.  I mean I think we pick securities from the bottom up and then think about the sort of macro risks after that.  So there are some good companies in Europe, there are some good companies in EM and bonds and the same in the US. I think at the moment the US probably looks a slightly safer bet than Europe but that is more tactical perhaps. Emerging markets, I mean I think it is about taking advantage of the volatility at the moment, taking advantage of the near-term weakness and recognising that if we are still 18 months/2 years or so from the next recession, actually if you can buy some of these things cheaply and the risk-reward looks attractive, then accumulating into weakness, limited exposure in emerging markets actually probably makes sense.

Lindsay Williams: John, thanks so much for your time this evening.  That is John Stopford, Head of Multi-Asset Income at Investec Asset Management in London. 

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