Italy: Repricing risk

Transcription

1 PERSPECTIVE MAY 2018 This is for investment professionals only and should not be relied upon by private investors Italy: Repricing risk ALBERTO CHIANDETTI Portfolio Manager, Equities ANDREA IANNELLI Investment Director, Fixed Income Italy s political developments have rocked both stocks and bonds. With a technical government now in charge and new elections back on the agenda, we may not have seen the end of this adjustment yet and increased market volatility is likely to persist. With hindsight, we may look back to the current turmoil and investor capitulation as a great buying opportunity. For now, however, it s difficult to choose the best time to catch the proverbial falling knife. It s been eight weeks since the Italian elections. After several weeks of negotiation between the two largest parties resulting from the polls - the Five Star Movement and the Lega - a coalition was finally achieved, with the market initially concerned by the deficit prone agenda put forward in the coalition programme. However, the focus quickly shifted to the question of the Euro, a topic that had rarely been discussed on the campaign trail. The coalition saw its plan rejected by the President of the Republic, Mr. Mattarella, who did not consider the coalition candidate for the role of Finance Minister, Mr. Savona, and his critical views towards the European project acceptable. With no room or willingness to compromise by the coalition parties, the mandate to form a government was eventually given to Carlo Cottarelli, an ex-imf official expected to hold the helm until fresh elections later in the autumn. The recent turn of events, unprecedented in Italy and in most European countries, has led to a constitutional crisis with elected parties challenging the role and remit of the President. The next elections will be very polarised with the vote becoming a view on Europe and on the country s political establishment. Important information The value of investments and the income from them can go down as well as up so you may get back less than you invest. Past performance is not a reliable indicator of future results. These materials are provided for information purposes only and are intended only for the person or entity to which it is sent. These materials do not constitute a distribution, an offer or solicitation to engage the investment management services of Fidelity, or an offer to buy or sell or the solicitation of any offer to buy or sell any securities or investment product. Fidelity makes no representations that the contents are appropriate for use in all locations or that the transactions or services discussed are available or appropriate for sale or use in all jurisdictions or countries or by all investors or counterparties. Investors should also note that the views expressed may no longer be current and may have already been acted upon by Fidelity. They are valid only as the of the date indicated and are subject to change without notice. Markets have not taken the latest developments lightly. The Italian equity market, the darling of Europe in the past two years, has given up all of its outperformance against broader European indices over that period, with bank stocks in particular taking a hit. Italy s government bond yields have jumped and spreads over their safer German equivalents have risen, with some contagion to Spanish and Portuguese bonds. All Italian fixed income assets are suffering but sovereign bonds (BTPs) more so than corporate bonds, possibly due to the higher liquidity in the former, both in cash and futures, which makes them a preferred vehicle to hedge broader country risk held in credit portfolios.

2 Rebased to 100 Chart 1: The end of Italy s equity market outperformance? May 16 Sep 16 Jan 17 May 17 Sep 17 Jan 18 May 18 FTSE MIB INDEX MSCI EUROPE U$ Source: Thomson Reuters, Fidelity International, May Politics versus fundamentals The situation remains extremely fluid and markets will continue to trade at the mercy of headlines and announcements. Italian assets will clearly trade with a high beta and the country s high debt-to-gdp ratio leaves little room for manoeuvre on the deficit, keeping investors wary. Rising yields will certainly be an unwelcome development for an issuer with such a high debt burden, and markets can act as automatic stabilisers should the fiscal stance become untenable. On the growth front, the economy is still 5.7 per cent smaller than before the financial crisis so plenty of work is still required. The instability that is now apparent, however, will stall, if not reverse, some of the more meaningful reforms recently implemented. On the economic front, conditions are not as much of a strain as they have been in the past. Domestic investors hold a larger share of the nation s debt than a decade ago, and the ECB is now a stable buyer of Italian sovereign bonds, of which it owns a not insignificant 14 per cent. Economic growth has been positive since 2013, the current account deficit has been in surplus for five years, and the fiscal deficit has more than halved since its 2009 peak. Corporate fundamentals have improved considerably in the past year, and the national champions among Italian banks have worked hard to improve their capital position, selling non-performing loans and improving profitability and margins. Chart 2: Improving GDP growth since % 3% 2% 1% 0% -1% -2% -3% -4% -5% -6% Italy Eurozone Year-on-year GDP growth. Source: Thomson Reuters, Fidelity international, May PERSPECTIVE Italy: Repricing risk 2

3 % Chart 3: High debt/gdp ratio Chart 4: But falling fiscal deficits 140% 120% 100% 80% 60% 40% 20% 0% Fiscal balance as percentage of GDP Source: Thomson Reuters, Fidelity International, May Source: Thomson Reuters, Fidelity International, May This helps to explain why risk premia, for example those reflected in bond spreads, have been rising but remain, at least for now, well below the levels recorded in , when Italy, along with much of the rest of Europe, was in recession. Chart 5: Widening spreads between Italian and German bonds BTP - Bund 10yr yield spread Source: Bloomberg, Fidelity international, May When to catch a falling knife? While Italy s fundamentals may have improved, there is no room for complacency. The country s high debt stock means that every additional basis point matters for its interest burden and market moves can ultimately change the fundamental picture. Although there are some mitigating factors, investors remain at the mercy of headlines while political tensions remain elevated; volatility will not ease much in this environment and further price corrections may occur. As we move towards a potential new election in the autumn, there is a chance that market participants and voters will see it as a vote on the Euro and on Italian and European institutions. It is still unclear whether 5 Star and Lega will use these as themes in the upcoming campaign. The latest price action, however, does indicate that some of this risk is being priced in. The promises of fiscal largesse, meanwhile, remain in place and will still be a feature of the main parties electoral programme, as will the reversal of the previous government s pension and labour market reforms. PERSPECTIVE Italy: Repricing risk 3

4 Lastly, there is a non-negligible risk of a downgrade of Italy s sovereign rating, which could further impact investor appetite for Italian assets. Crucially, should all four major rating agencies downgrade Italy to high yield, the ECB would be unable to continue buying BTPs as part of its PSPP programme. This is not our base case, however, in light of past experiences with other peripheral countries, namely Portugal, which remained ECB-eligible despite having worse fundamentals compared to Italy. But how much of these scenarios are already priced in? While political risk is notoriously difficult to price, valuations now appear a little more balanced following the underperformance of Italian assets and can offer opportunities to investors willing to weather the volatility and dig a little deeper into corporate fundamentals. Many Italian companies, for example, are not all that exposed to the domestic market, which accounts for less than half of their sales in aggregate. Shares of Italy-based global companies in interesting niche areas or sectors may get caught up in local selloffs despite little change to their fundamental outlook. Similarly, on the fixed income side, financials have suffered due to the large holdings of BTPs that Italian banks have. The largest Italian banks, the national champions, however, are in a much better position now than they were in Balance sheets are now stronger than in the recent past, following the successful disposal of NPLs achieved in the last two years. They may even see their market share improve as investors shift their deposits to larger institutions they perceive as safer during periods of heightened volatility. However, caution is still warranted. The new volatility regime changes the risk and reward proposition for Italian assets and, by extension, across for the wider southern European periphery, at least until we get better clarity on how the Italian political situation will evolve. PERSPECTIVE Italy: Repricing risk 4

5 Important information This material was created by Fidelity International.. It must not be reproduced or circulated to any other party without prior permission of Fidelity. This communication is not directed at, and must not be acted on by persons inside the United States and is otherwise only directed at persons residing in jurisdictions where the relevant funds are authorised for distribution or where no such authorisation is required. Fidelity is not authorised to manage or distribute investment funds or products in, or to provide investment management or advisory services to persons resident in, mainland China. All persons and entities accessing the information do so on their own initiative and are responsible for compliance with applicable local laws and regulations and should consult their professional advisers. This content may contain materials from third-parties which are supplied by companies that are not affiliated with any Fidelity entity (Third-Party Content). Fidelity has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. Fidelity International refers to the group of companies which form the global investment management organisation that provides products and services in designated jurisdictions outside of North America Fidelity, Fidelity International, the Fidelity International logo and F symbol are trademarks of FIL Limited. Fidelity only offers information on products and services and does not provide investment advice personal recommendations based on individual circumstances. Issued in Europe: Issued by FIL Investments International (FCA registered number ) a firm authorised and regulated by the Financial Conduct Authority, FIL (Luxembourg) S.A., authorised and supervised by the CSSF (Commission de Surveillance du Secteur Financier) and FIL Investment Switzerland AG, authorised and supervised by the Swiss Financial Market Supervisory Authority FINMA. For German wholesale clients issued by FIL Investment Services GmbH, Kastanienhöhe 1, Kronberg im Taunus. For German institutional clients issued by FIL Investments International Niederlassung Frankfurt. In Hong Kong, this content is issued by FIL Investment Management (Hong Kong) Limited and it has not been reviewed by the Securities and Future Commission. FIL Investment Management (Singapore) Limited (Co. Reg. No: E) is the legal representative of Fidelity International in Singapore. FIL Asset Management (Korea) Limited is the legal representative of Fidelity International in Korea. In Taiwan, independently operated by FIL Securities (Taiwan ) Limited, 11F, 68 Zhongxiao East Road., Section 5, Xinyi Dist., Taipei City, Taiwan 11065, R.O.C. Customer Service Number: #2 1C PERSPECTIVE Italy: Repricing risk 5