Italy's 'Lost Decades'

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by: Rob Marstrand

Things change quickly!

Last week I highlighted how the summit meeting between Donald Trump and Kim Jong-un had been cancelled. Now, reports suggest it could be back on. Apparently, Kim doesn’t read cancellation letters and Trump forgets sending them. Still, this is good news. I’d always prefer to see leaders holding talks rather than trading public insults and bragging about the size of their nuclear buttons.

In another turnaround, Italy looked on track last week to finally form a coalition government, following split elections in March. That proposal has now fallen apart. Italian President Sergio Mattarella, who occupies a largely ceremonial role but with certain significant powers, got in the way. It appears that Mattarella vetoed the League / Five Star Movement candidate for finance minister, an 82 year-old eurosceptic called Paolo Savona. A “caretaker” (translation: unelected technocrat) prime minister called Carlo Cottarelli will be appointed until new elections, to be held either later this year or in early 2019. Cottarelli is an ex-IMF economist with a reputation for making cuts to public spending.

Italian stocks and bonds have taken a hit as investors take stock of the uncertainties. Italian 10-year government bonds now yield 2.91%. That yield jumped +0.26% today and +1.19% over the past month.

The current Italian yield is 2.59% above German 10-year bunds. I still remember the run up to the introduction of the euro in 1998, when bond traders made a killing on the “convergence trade”, as bond yields across the eurozone got closer to each other. Now they’re diverging once again, indicating that traders realise not all countries are born equal in the great euro project.

As for Italian stocks, they’ve lost 13% since 7th May. In US dollar terms, the MSCI Italy index has gone nowhere for years. In fact, staggering as this may seem, the index is barely above the peak it reached in 1987!

Some have described the Italian political developments as a “coup” organised by Brussels. Others say that it’s exactly what the anti-establishment parties want, since it gives them a reason to rally even more votes next time. Whatever the truth, it kicks the eurosceptic can down the road but doesn’t address the discontent. As I’ve said many, many times before, I believe the EU’s troubles are only just getting started.

For example see here – something I wrote during Italy’s last political crisis in late 2016. At the end I said: “Investors need to be more selective than ever as the cracks grow bigger in the EU empire.” That’s just as true today as it was then… perhaps more so. (That said, there are plenty of great European companies with global businesses. Buying the stocks at the right prices will still work out well.)

The 2016 Brexit vote in the UK was a shock to the Brussels system, but there’s little sign of deep reform. For now, the rest of the EU remains intact. But my bet is that it’s only one decent recession away from major political upheavals in several countries. Remember, Marine Le Pen’s nationalist Front National came second in French elections in early 2017, with 34% of the vote in the second round. Although Le Pen lost, that result was something that no one in the European political establishment could have contemplated only a few years earlier. Anti-establishment parties are waiting in the wings in many European countries. Eventually, one or more of them will gain power and challenge Brussels.

This week it’s Italy’s turn to give investors pause for thought, but there are always uncertainties in the world and in markets. That’s why it’s essential that you’re patient and invest in beaten down stocks of strong, growing companies with solid finances (see here). They’ll deliver great results, sooner or later.

Disclosure: OfWealth expressly prohibits its writers from having a financial interest in any individual securities they recommend to their readers, other than collective investments such as exchange traded funds.