Trade continues to dominate the headlines with Donald Trump’s tweets around US tariffs driving sentiment. The emergence of China’s appetite to use its currency as a shock absorber also added volatility. August’s volumes are traditionally lighter and that helped catalyse a very weak start for US equities albeit a lot of the losses had been erased by the end of the week.
It has become traditional that on the eve of my summer holiday in Italy that some sort of crisis comes to the fore there. This is perhaps not overly surprising given since Italy joined the Euro in 1999 they have seen stagnant real GDP growth of less than 0.5% against a government debt to GDP burden of 131% of GDP. As the chart in this week’s video shows, since the depths of the financial crisis, Italy’s GDP per capita has never recovered, in stark contrast to other developed market nations. This fragile economic backdrop leads to a fractious political backdrop and it as a result of this that the current Italian government is the 66th since World War II.
That’s a lot of change, when you consider over the same time, the UK with Boris Johnson has only just entered its 16th change in Prime Minister (although it seems the UK is doing its best to make up for lost time recently). The electoral differences explain much of the difference between the two countries’ experiences; Italy has proportional representation as part of their electoral rules, though new rules last year also introduced elements of a British-style first-past-the-post. Broadly speaking, in Italy, just over a third of seats are decided by winner-takes-all votes in individual constituencies, with the rest allocated in proportion to the number of votes each party receives.
Italy’s ruling populist collation now looks to be heading for collapse after the technocratic PM Guiseppe Conte said this week that he would start proceedings to recall the Italian parliament for a vote of no-confidence, a vote which has been requested by one half of the two-party ruling coalition – Matteo Salvini, League party leader, who has been at odds against his coalition partner Luigi Di Maio, the leader of Five-Star. Ultimately, the decision for new elections rests with the Italian President Sergio Mattarella, but these latest developments add to uncertainty for markets.
The Italian government is expected to miss its 2% GDP budget deficit target in 2019, with forecasts from the European Commission running at around a 2.5% deficit this year, rising to 3.5% in 2020. The breach of the EU’s 3% limit would be the first for Italy since 2011. While there is some difference in view as to whether Italy might push through planned VAT hikes to help reduce the deficit a little, Italy arguably needs more reforms to improve the path of the deficit longer-term, and here there seems to be little political appetite currently from Italy’s side. Instead, Italy has looked to park the blame on the European institutions.
If we do see an election it is likely to be neatly parked within the end of October corridor of uncertainty for the Eurozone. On 20th October we have the deadline for the Italian budget, 31st the Brexit deadline and on 1st November a change of leadership at the major EU institutions. None of this makes European equities look particularly exciting despite the relatively cheap valuations on offer.
The above article was previously published by Brooks Macdonald on 12th August 2019