Populist politics in Italy suggest a summer of uncertainty

Neil Dwane | 31/05/2018
Populist politics in Italy suggest a summer of uncertainty

Summary

The recent political turmoil in Italy has thrown a renewed spotlight on the challenges facing the country. Despite signs of improvement in its economic situation, helped by a stronger global economy and firming domestic demand, several factors weigh heavily on the outlook for Italy – including wider euro-zone uncertainty and the drop-off in cyclical growth momentum globally. Navigating these issues will be top of the agenda for the country’s next government.

Key takeaways

  • While hopes are rising of a resolution to the political upheaval in Italy, investors will be focused on the country’s weaker economic outlook
  • Italy’s economy has been doing better, but confidence could be threatened by rising yields and uncertainty, despite some proposed fiscal stimulus and lower taxes
  • Despite market fears, there appears to be little appetite among Italians to leave the euro, as differences centre on the constraints of EU budget levels
  • We don’t foresee any major response from the ECB to Italy’s troubles; market pressures should help direct a sensible set of domestic policies
  • We remain neutral to cautious on Italian assets for now as we face a summer of uncertainty

The political upheaval in Italy has raised a number of fears, not least that Europe’s fourth-largest economy may want to withdraw from the EU, if not subvert the euro with a parallel currency too. We view both events as unlikely, but the mere prospect of them occurring – amid continuing political uncertainty – caused cascading market reactions: yields on Italian debt soared as prices plummeted; a selloff in Italian equity markets spilled over to the US; and the euro fell to its lowest level against the US dollar this year. At the climax of the recent crisis, markets were pricing in a high probability of default on Italian debt, with no possibility of outright monetary transactions (OMT) by the ECB. The subsequent re-steepening of the yield curve is a welcome sign of normalisation.

Two possibilities: elections in September or a new political government

The political environment in Italy is fast-changing. Since parliamentary elections in March, which resulted in a hung parliament with no party or coalition winning a majority of seats, Italy hasn’t had a government. On 27 May, President Sergio Mattarella rejected the nomination of an economics minister whom he considered anti-EU and anti-euro. This triggered the latest surge of market volatility globally and raised the spectre of his impeachment.

From our perspective, Italy’s political situation boils down to two possibilities – both of which are likely to create a degree of certainty that may buoy financial markets in the short term:

  • The first is the formation of a caretaker government, led by interim Prime Minister Carlo Cottarelli, followed by a new round of elections that would effectively be a referendum on Italy’s role in the EU. We believe that September is a more likely date for these elections.
  • The second possible scenario is the formation of a new political government, possibly with the Five Star Movement and the League party; or a centre-right government led by the League (albeit an unlikely outcome without a snap election).

If new elections are held, a populist outcome could be more hostile to the EU’s leadership. Then again, recent events could trigger an earnest dialogue with the EU, which would not want Italy to leave the union. Until then, we expect that the EU will be in a mostly wait-and-see mode, and that it will not interfere with Italy’s affairs.

Economic and market outlook: headwinds persist

Even before recent events in Italy, the global markets were facing a few headwinds:

  • The first is that leading economic indicators may be “rolling over” as the global economy moves into a late-cycle stage of growth. We don’t anticipate this will result in a hard landing for the world’s major economies, let alone recession, but less cyclical momentum implies less momentum for risky assets.
  • The second is a general sense of political uncertainty. This is an issue that we believe will persist on a global scale for some time, considering that the underlying reasons for populism’s rise are not going away: growing inequality, threats from automation and an anti-globalisation mood – as already exemplified by Brexit.

What’s surprising is that Italy’s voters have recently been voting for anti-establishment parties even though the country’s economy has been doing better. The euro is less popular in Italy than it was a few years ago, which has unnerved politicians throughout the EU. Yet we believe this mood would change before elections are held: given the market pressure that is severely hurting Italian assets, we suspect that Italian voters would think twice before voting against the euro.

Investment implications: a summer of uncertainty

We were already cautious on Italian government debt, and recent events have not changed our stance. We expect continued volatility over the summer, particularly given that the European Central Bank is set to begin withdrawing quantitative easing. The ensuing rise in interest rates would be a key issue for the affordability of Italian debt, and it could have global implications given that Italy is the third-largest borrower in the world.

Italian equities were generally doing well before recent events as the country’s economic cycle improved and earnings growth looked positive. But Europe seems to be a centre of uncertainty for global investors, as recent troubles in Spain have added to those in Italy. The selloff of euro-zone banks seen in recent days has been driven by systemic fears, the banks’ holdings of Italian sovereign debt and a lack of interest-rate rises as the ECB ends quantitative easing (QE) later this year. We believe these fears are exaggerated, yet we expect investors to stay cautious on European equities – particularly given the potential for a summer of negative news headlines.

Globally, monetary policy will continue normalising, but central banks will watch carefully for any signs of contagion in their economies. Italy’s crisis could also encourage the US Federal Reserve to raise rates more quickly. As liquidity provided by central banks is pulled back, it does not necessarily imply that markets will fall, but we believe it may become more difficult for markets to move much higher. Investors should brace for additional market volatility, particularly given the potential for cyclical economic data to weaken.



Investing involves risk. The value of an investment and the income from it will fluctuate and investors may not get back the principal invested. Past performance is not indicative of future performance. This is a marketing communication. It is for informational purposes only. This document does not constitute investment advice or a recommendation to buy, sell or hold any security and shall not be deemed an offer to sell or a solicitation of an offer to buy any security. The views and opinions expressed herein, which are subject to change without notice, are those of the issuer or its affiliated companies at the time of publication. Certain data used are derived from various sources believed to be reliable, but the accuracy or completeness of the date is not guaranteed an no liability is assumed for any direct or consequential losses arising from their use. The duplication, publication, extraction or transmission of the contents, irrespective of the form, is not permitted. This material has not been reviewed by any regulatory authorities. In mainland China, it is used only as supporting material to the offshore investment products offered by commercial banks under the Qualified Domestic Institutional Investors scheme pursuant to applicable rules and regulations. This document is being distributed by the following Allianz Global Investors companies: Allianz Global Investors U.S. LLC, an investment adviser registered with the U.S. Securities and Exchange Commission; Allianz Global Investors GmbH, an investment company in Germany, authorized by the German Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin); Allianz Global Investors Asia Pacific Ltd., licensed by the Hong Kong Securities and Futures Commission; Allianz Global Investors Singapore Ltd., regulated by the Monetary Authority of Singapore [Company Registration No. 199907169Z; Allianz Global Investors Japan Co., Ltd., registered in Japan as a Financial Instruments Business Operator [Registered No. The Director of Kanto Local Finance Bureau (Financial Instruments Business Operator), No. 424, Member of Japan Investment Advisers Association and Investment Trust Association, Japan]; and Allianz Global Investors Taiwan Ltd., licensed by Financial Supervisory Commission in Taiwan.

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Neil Dwane

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Global Strategist
Neil Dwane is a portfolio manager and the Global Strategist with Allianz Global Investors, which he joined in 2001. He coordinates and chairs the Global Policy Committee, which formulates the firm’s house view, leads the firm’s bi-annual Investment Forums and communicates the firm’s investment outlook through articles and press appearances. Neil is a member of AllianzGI’s Equity Investment Management Group. He previously worked at JP Morgan Investment Management as a UK and European specialist portfolio manager; at Fleming Investment Management; and at Kleinwort Benson Investment Management as an analyst and a fund manager. He has a B.A. in classics from Durham University and is a member of the Institute of Chartered Accountants.

A region on the rise: key conclusions from our Asia Conference

Neil Dwane | 04/06/2018
Asia Conference

Summary

Our clients and investment professionals recently met in Berlin for our 10th annual Asia Conference. Here are some of the highlights from two days of discussions about the world’s most dynamic region.

Key takeaways

  • Standards for corporate governance and behaviour are rising rapidly across Asia amid a greater focus on ESG factors
  • For investors, Asian politics are less worrisome than US or European politics; Brexit negotiations and Italy’s discontent with the EU may be more pressing
  • Global trade is still important to Asia, but as every year passes, the region’s growth becomes more and more self-sustained – especially with “One Belt, One Road” projects
  • Built on strong long-term fundamentals, Asian equities and bonds offer investors the potential for solid returns and risk diversification

ESG investing is on the rise

While Asia once lagged Europe in many environmental, social and governance (ESG) issues, an increasing number of governments and corporations in Asia are paying close attention to ESG factors. We expect this shift will gain momentum as the region’s markets continue to develop.

  • In Japan, Prime Minister Shinzo Abe’s government and major pension funds are pressing for improved diversity, shareholder representation and management accountability.
  • China is changing its “growth at any cost” model of the last 25 years; President Xi Jinping knows the importance of delivering better living standards and a cleaner environment.
  • South Korea is also making progress on its ESG journey, making efforts to address all-too-common management scandals and bribery issues.
  • India still relies on domestic coal but is keenly aware of the unpopular costs of growth at the expense of the environment, particularly given the country’s large farming population.

Politicians are driving significant reforms

Politicians know that the best way to get and stay popular is through sustained economic growth. Many Asian governments are focused on adapting their economic business models. They recognise that supplying goods to tapped-out US and European consumers will not work for much longer.

China is leading the region’s reform efforts, aiming to rebalance its economy away from exports and manufacturing towards consumption and services. Indeed, China’s spending on consumer needs and essentials is already falling, leaving more room for discretionary spending.

In India, Prime Minister Narendra Modi is moving his country forward along similar lines, restructuring the country’s banks and inefficient monetary system through an aggressive “demonetisation” plan. A better biometric-based identification system called Aadhaar should make government services, such as welfare, more targeted and less susceptible to fraud.

With general elections due in 2019, India does, however, face significant electoral unknowns. But greater political uncertainty exists in the European Union, which is grappling with Brexit and with Italy’s threats to flout the EU’s rules – or even withdraw from the monetary union.

Trade troubles won’t derail Asia’s high-tech shift

In recent months, trade friction between Asia and the United States created a steady flow of worrisome headlines for good reason. Trade wars help no one, particularly big exporters such as Japan, China and South Korea. Although US President Donald Trump seems to have softened his initially hard-line stance towards China, it is unclear whether new tariffs are officially off the table – particularly with regard to technology. Asia’s regionally efficient supply chains mean the negative effects of tariffs can quickly spread; consider how the technology sectors in the US and China are inextricably linked with South Korea, Taiwan and other countries.

Yet Asia’s tech sector is on a good trajectory. At some point in the next few years, Asia appears set to become the largest investor in research and development (R&D) globally, intensifying a high-tech race with the US. Moreover, denying Asia’s economies access to US technology could simply fuel the need for local Asian tech.

Green tech and infrastructure are spurring development

As Asian economies grow, they will come under the same pressure as their US and European counterparts to make that growth sustainable from an environmental perspective. The good news is that many leading economies – in Asia and elsewhere – may now be able to grow even as they decrease the negative environmental impact of that growth. China is leading the way with a strong emphasis on developing green technologies such as solar power and electric vehicles, as well as sustainable food sources through better R&D and agricultural practices.

Infrastructure is also a major development theme for the region. India, Vietnam and Indonesia are addressing their huge infrastructure deficits in the hopes of sustaining strong, open and competitive economies. Asia as a whole is also supported by China’s huge “One Belt, One Road” plan, which is primarily an infrastructure project but could have a halo effect on employment and services development – particularly in Sri Lanka, Vietnam, Pakistan and Bangladesh.

China is opening up its equity markets

China has been taking measured steps to open up its currency, bond and equity markets to international investors even as it carefully controls the flight of capital out of the country. Yet despite an abundance of caution, China’s market reforms are working well – and being expanded. This is turning Chinese equities from an asset class that many investors ignored into one that is being taken seriously, particularly with China A-shares set to be included in the MSCI Emerging Market index this summer.

(For more insights into China, read “China's Year of the Dog bounds into view” and “10 key facts about China A-shares”.)

Growth and income are top investment themes

Asia’s compelling structural growth story provides investors with a host of access points:

  • Asia’s millennials are reshaping their economies and driving the adoption of new technologies and services. Asia’s focus on R&D is also giving the US a run for its money with big data and artificial intelligence.
  • The prospect of less trade with the US and Europe could push Asian companies to focus more on the new emerging-markets consumer, many of whom may at first only be able to afford regional brands rather than those of global multinationals.
  • Equity investors will find that many Asian companies boast less debt and better longer-term fundamentals than their Western counterparts – in addition to solid earnings and dividend growth potential.

For fixed-income investors, Asia also offers the ability to boost return potential and diversification – particularly for portfolios overexposed to US high yield or overly sensitive to Federal Reserve policy. Thanks to its growing markets and rising domestic investment by local investors, Asia should be whipsawed less by US investors in years to come. Instead, the region will be powered by sound economic policy, strong fundamentals and exciting investment opportunities from both equities and bonds.

Investing involves risk. The value of an investment and the income from it will fluctuate and investors may not get back the principal invested. Past performance is not indicative of future performance. This is a marketing communication. It is for informational purposes only. This document does not constitute investment advice or a recommendation to buy, sell or hold any security and shall not be deemed an offer to sell or a solicitation of an offer to buy any security. The views and opinions expressed herein, which are subject to change without notice, are those of the issuer or its affiliated companies at the time of publication. Certain data used are derived from various sources believed to be reliable, but the accuracy or completeness of the date is not guaranteed an no liability is assumed for any direct or consequential losses arising from their use. The duplication, publication, extraction or transmission of the contents, irrespective of the form, is not permitted. This material has not been reviewed by any regulatory authorities. In mainland China, it is used only as supporting material to the offshore investment products offered by commercial banks under the Qualified Domestic Institutional Investors scheme pursuant to applicable rules and regulations. This document is being distributed by the following Allianz Global Investors companies: Allianz Global Investors U.S. LLC, an investment adviser registered with the U.S. Securities and Exchange Commission; Allianz Global Investors GmbH, an investment company in Germany, authorized by the German Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin); Allianz Global Investors Asia Pacific Ltd., licensed by the Hong Kong Securities and Futures Commission; Allianz Global Investors Singapore Ltd., regulated by the Monetary Authority of Singapore [Company Registration No. 199907169Z; Allianz Global Investors Japan Co., Ltd., registered in Japan as a Financial Instruments Business Operator [Registered No. The Director of Kanto Local Finance Bureau (Financial Instruments Business Operator), No. 424, Member of Japan Investment Advisers Association and Investment Trust Association, Japan]; and Allianz Global Investors Taiwan Ltd., licensed by Financial Supervisory Commission in Taiwan.

517653

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Neil Dwane

linkedIn
Global Strategist
Neil Dwane is a portfolio manager and the Global Strategist with Allianz Global Investors, which he joined in 2001. He coordinates and chairs the Global Policy Committee, which formulates the firm’s house view, leads the firm’s bi-annual Investment Forums and communicates the firm’s investment outlook through articles and press appearances. Neil is a member of AllianzGI’s Equity Investment Management Group. He previously worked at JP Morgan Investment Management as a UK and European specialist portfolio manager; at Fleming Investment Management; and at Kleinwort Benson Investment Management as an analyst and a fund manager. He has a B.A. in classics from Durham University and is a member of the Institute of Chartered Accountants.
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