MarketMinder Europe 

MarketMinder Europe

MarketMinder Europe provides our perspective on current issues in financial markets, investing and economics. Our goal is to analyse key topics in an entertaining and easy to understand manner, helping you see the news of the day in a unique perspective.

Investing in financial markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid. Past performance neither guarantees nor reliably indicates future performance. The value of investments and the income from them will fluctuate with world financial markets and international currency exchange rates.

Italy’s Coalition Is Kaput

On Tuesday, Italy’s government collapsed when Prime Minister Giuseppe Conte resigned ahead of a looming no-confidence vote, ending the alliance between the anti-establishment Five Star Movement (M5S) and nationalist League. League leader Matteo Salvini called for the no-confidence vote 8 August, but opposition lawmakers delayed it in an effort to buy time to explore alternative alliances. In the coming days, we will likely find out whether they were successful—or whether the country will hold new elections, perhaps as soon as October. So for now, we think political uncertainty likely lingers. Longer term, however, the likelihood of an Italian government—regardless of who leads it—passing major, market-disrupting change appears low, in our view.

According to the coverage in news outlets we follow, Salvini triggered his own government’s fall because he wants new elections. Whilst the League currently has 91 fewer seats in the lower house than M5S, its poll numbers have soared since last year’s election. The latest poll averages give the League 36% and its would-be coalition partners, Silvio Berlusconi’s Forza Italia and the far-right Brothers of Italy, 6% and 7%, respectively.[i] M5S is down to 19%, and the PD has 23%.[ii] Striking whilst the iron is hot appears to be Salvini’s strategy.

But Salvini doesn’t get to call new elections. That power rests with President Sergio Mattarella. Whether he calls them will likely depend on whether M5S and the centre-left Democratic Party (PD) can form a stable government and convince Mattarella of their staying power. This isn’t outside the realm of possibility. Together, they have 327 seats in the 630-seat lower house, enough for a small majority. Unlike M5S and the League, they look like they are more ideologically aligned. But until last week, they had a public record as bitter rivals. Their potential rapprochement—if consummated—would probably be a marriage of convenience to keep Salvini from getting his way. That was apparently enough to get them to join forces to block his no-confidence vote when he first submitted it two weeks ago, but whether it gets them to agree on a governing programme is likely another matter.

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Brexit’s Next Act Seems Cast, but the Script Still Looks Missing

Tuesday morning, one tiny piece of UK politics seems a touch clearer: Boris Johnson (or “BoJo” for short)—former Foreign Secretary and London mayor—took 66% of the vote in the Conservative Party’s leadership contest, meaning he will replace Theresa May as Prime Minister. Whilst this sheds a little light on the cast of characters in Brexit’s next act, we don’t think it adds much clarity beyond that. How the UK/EU relationship will look post-Brexit remains unknowable, in our view. Many in our news surveys speculate his victory means no-deal is more likely, but we think this is a vast oversimplification. Though we wish his election cleared the Brexit fog, it doesn’t, in our view.

Johnson was one of Brexit’s chief flagbearers prior to 2016’s referendum and is generally considered a staunch eurosceptic in publications we read regularly. He touted a “do or die” approach to Brexit whilst campaigning, claiming 31 October would be the final date Britain is in the EU—deal or no. Johnson even hinted at doing an end-run around Parliament to accomplish this.[i] Naturally, given the hyper-focus in Europe on Brexit amongst media we follow, this stole most headlines tied to the campaign.

But this speculation overrates political rhetoric by a wide margin, in our view. For one, Johnson said a lot of things on the campaign trail. Yes, he seemed to occasionally toe a hard line on the EU—which was likely necessary for him to win eurosceptic Tories’ support. He also said he thought the odds of a no-deal Brexit were “a million-to-one against” in late June. Perhaps that is also politicking. (It was also when Johnson’s opponent, Jeremy Hunt, said similarly contradictory things on Brexit.)[ii] As the old joke goes: How do you know when a politician is lying? Simple—their lips are moving.

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Europe Has a Parliament—and Gridlock

Editors’ Note: Our political commentary is nonpartisan by design. We favour no party, politician or elected official in any country and assess political developments solely for their potential economic or financial market impact.

The dust has settled after late-May’s European Parliamentary elections, and the winners are becoming clear: everyone and no one! Ok, perhaps that is a bit oversimplified. But pro-European parties combined for more than 50% of available seats—seemingly a victory of sorts.[i] Then again, the two biggest centrist groupings lost their combined majority for the first time since the European Parliament launched in 1979. Populist and eurosceptic parties combined for a largest-ever total of 25% of seats. But those populists aren’t unified, and no faction won anywhere near enough seats to get a meaningful place at the table. Meanwhile, both pro- and anti-Brexit parties in the UK are claiming victory, whilst one of Italy’s ruling populist parties appears to be claiming a newfound mandate. For investors, we think the outcome is much simpler: entrenched gridlock, which should provide relief to European shares, in our view.

Exhibit 1 shows the latest tally. The two traditional groups—the centre-right European People’s Party (EPP) and centre-left Progressive Alliance of Socialists and Democrats (S&D)—took first and second place, respectively, but combined for only 44.1% of seats.[ii] However, a third centrist group, the Alliance of Liberals and Democrats for Europe (ALDE) and its allies, took third place with 14% of seats, giving a three-way centrist coalition an easy majority if that is the road party leaders decide to take. Throughout the coverage we read, political analysts worldwide seem to think this is the likeliest outcome, perhaps with the Green Party joining. We suppose a left-leaning coalition of S&D, ALDE, Greens, leftists and the populist Europe of Freedom and Direct Democracy (EFDD) is also possible, as is some other fractured hodgepodge. But whatever coalition ultimately emerges, simple maths suggest it will have at least three main parties—a recipe for internal disagreements and next to nothing happening, in our view. We suspect populist parties will probably spend most of their time making rousing speeches from the back benches, not writing radical legislation.

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May’s End Heralds May’s End

Editors’ Note: Our political commentary is non-partisan by design. We favour no political party, candidate or elected official in any country and assess political developments solely for their potential economic or financial market impact.

As the month of May closed, the world still didn’t have an answer to the biggest question surrounding Prime Minister Theresa May: whether she would accept Geri Horner’s (née Halliwell, aka Ginger Spice) invitation to the Spice Girls’ reunion tour. However, we do now know May will resign as Conservative Party leader on 7 June, assuming the role of caretaker prime minister as her party selects a new leader over the summer. Whilst this is big news, we don’t think it signifies some huge change. The Conservative Party remains beset with internal divisions. Parliament still hasn’t passed an EU withdrawal bill, and no one knows what the next iteration of said bill will look like. Nor does anyone know who will be shepherding that bill as prime minister or whether they will try to renegotiate with Brussels. Halloween remains the Brexit deadline—yet no one knows whether this will be the date of a hard Brexit, soft Brexit or another delay. It seems to us a summer of uncertainty looms—and in our view, the sooner this circus ends, bringing clarity to UK businesses and investors, the better off equity markets are likely to be.

At this point, we see two big questions. First, who will succeed May? Second, will a snap election follow—something Labour leader Jeremy Corbyn pushes for regularly. The answers, in our view, are “unknown” and “unknown.” Polls show voters overwhelmingly prefer former London Mayor Boris Johnson, who spearheaded the Brexit campaign and has pushed for a hard Brexit ever since. But the wider Conservative Party base may not get a say, due to the party’s selection rules. Unlike Labour, which lets all party members vote in a free-for-all—which is how Corbyn became leader despite not having MPs’ broad backing—the Conservatives give their MPs first crack. MPs nominate a slate of candidates and then conduct secret votes until just two candidates remain. Those two then go to all registered party members for a vote. The whole process typically takes about two months.

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On Australia’s Election ‘Surprise’ and Dodgy Narratives

Editors’ Note: Our political analysis is nonpartisan by design. We favour no party nor any candidate in any country and believe partisan bias is the road to investment error.

Surprising pollsters and political pundits globally, Australia’s incumbent Liberal-National Coalition, led by Prime Minister Scott Morrison, eked out a win at Sunday’s election. The count isn’t quite finished yet, but present tallies award them at least 76 seats, the exact number they would need for a majority.[i] Most coverage we have seen portrays the result as a shocker. Depending on the political slant of the coverage you read, you might have heard that this was a victory of right-wing populism over a climate change agenda—or a victory of sensible economic policy over left-wing populism.[ii] That, to us, is merely a statement about the hyper-politicised nature of our world and investors’ need to cut through bias when assessing political events. Best as we can tell, this is a story of how a behavioural concept known as loss aversion—humans’ tendency to feel potential losses more acutely than potential gains—can hold big sway at the ballot box, as well as a lesson in the risk of leaning too much on polling numbers when considering politics’ impact on financial markets.

In our review of news, most pundits we saw couched Australia’s election as an epic showdown between the left and right—educated urban liberals in one corner of the proverbial boxing ring and rural conservatives in the other. Green city-dwellers versus people whose towns and counties depend on mining income. Idealistic young people in favour of redistribution to tackle inequality, versus those who favour tax cuts and job creation. We can understand the temptation to cling to these narratives, given the well-documented urban/rural political divide in America, the UK and much of Europe. That has been a consistent political story since non-urban voters swung 2016’s Brexit referendum. There may be something to all of those claims. Yet beneath the noise, we think the most contentious issue was a provision known as “dividend franking,” where investors get a tax credit on dividends that are paid with companies’ after-tax profits. This system not only prevents double-taxation of corporate profits, but it helps individual investors reduce their tax burden, making life easier on retirees living off their investments.

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One Year Later Italy Seems Fine

A year ago, financial pundits seemingly couldn’t stop writing of the risks lurking in Italy’s chaotic political scene. Two months after a general election, political leaders still hadn’t formed a government, but the potential for a populist coalition between the anti-establishment Five Star Movement and far-right The League loomed large. Many publications we monitored warned of the possibility for the eurozone’s third-largest economy to spiral into political chaos, recession and—if a populist government implemented all of its parties’ campaign pledges—fail to make interest or principal payments on its sovereign debt. Some thought Italian interest rates would soon soar as the very populist government many dreaded indeed took power at May’s close, and as economic data weakened in 2018’s second half, they suspected the worst fears were coming true.[i] Yet now, a year later, checking in on Italy’s situation reveals the government hasn’t done much, in our view, whilst interest rates are down, and gross domestic product (GDP, a government-produced estimate of national economic output) is growing again.[ii] For investors, we think this highlights a timeless lesson: Financial publications’ big headline fears fizzle frequently, leaving a benign reality in their wake.

When Italy’s populist parties formed a government, they shook up status quo politics. They pledged bold policy initiatives, made incendiary statements and vowed to take on the eurozone political establishment. They hinted they wouldn’t abide deficit limits and edicts from Brussels bureaucrats, whilst championing greater social welfare, flat taxes and infrastructure improvements. We think it is fair to say populist parties’ manifestoes shook Italy’s traditional political centre and, for a while, its markets. Italian 10-year government bond yields jumped from below 2% on the early-March election day to more than 3.6% in October, amidst budget disagreements between Rome and Brussels, which sparked debt default fears.[iii] Meanwhile, Italian GDP fell two straight quarters in Q3 and Q4 2018, meeting one popular definition of recession.[iv]

Today, the political, economic and financial environment appears calmer. Rome and Brussels resolved their budget dispute, and Italian 10-year yields are down to 2.55%, effectively even with 10-year US Treasury yields.[v] Q1 Italian GDP rose 0.2% q/q, perhaps signalling the start of an economic recovery.[vi] Even last year’s GDP contraction looks more benign than many initially thought, with government spending and a drop in private inventories being the sole negative contributors in Q4 2018.[vii] Pure private sector components, which we view as final consumption expenditure and gross fixed capital formation, were positive.[viii] Q4 growth in these areas wasn’t spectacular, in our view, but it also wasn’t negative. Now that GDP overall has resumed growing, we think Italy’s underlying growth drivers may be more visible.

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About That Robust UK Retail Sales Report

UK retail sales had a bangish March, jumping 1.1% m/m and a whopping 6.7% y/y, according to the Office for National Statistics. Headlines had a field day, marvelling at shoppers’ ability to “ignore Brexit chaos,” “defy Brexit turmoil” and hit the shops “unfazed by Brexit.”[i] This does seem like a testament to the nation’s stiff upper lip. However, whilst we don’t share the widespread view of Brexit (particularly a no-deal Brexit) as automatic economic or equity market doom, we do wonder if March’s sales jump is really a case of shoppers defying conventional wisdom—or if it is instead another instance of Brits prepping for a no-deal Brexit that didn’t end up happening.

Take a stroll down memory lane and recall mid-March. Politicians were nowhere close to a Brexit deal, and the 29th of the month loomed as the date Britain would supposedly crash out of the EU. Headlines had warned you for months that UK residents could lose access to popular continental European products, not to mention necessities like medicine. In the face of such warnings, stocking up likely seemed wise and logical! It wouldn’t surprise us if many shoppers hit the high street with such a mindset.

This is just one speculative interpretation, of course, but it wouldn’t be the only instance of stockpiling. For months, IHS Markit’s Purchasing Managers’ Indexes (PMIs)—monthly surveys tracking broad business activity—for the UK showed soaring inventories. March’s manufacturing PMI release opened with this statement: “The impact of Brexit preparations remained a prominent feature at manufacturers in March. Efforts to build safety stocks led to survey-record increases in inventories of both purchases and finished products. Trends in output and employment also strengthened as stockpiling operations at clients led to improved inflows of new work.”[ii] In other words, pre-Brexit scrambling and hoarding likely deserved most of the credit for the manufacturing PMI hitting a 13-month high.

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The European Central Bank’s New ‘Stimulus’ Probably Isn’t Too Stimulating

The European Central Bank (ECB) is attempting to boost the economy! Or at least that is how it—and the financial media we reviewed—are portraying ECB President Mario Draghi’s decision last week to renew the central bank’s “targeted longer-term refinancing operations” (TLTROs). Financial media we surveyed commonly described it as a “major policy reversal” and a “U-turn,” bringing back major economic stimulus.  We think this gives the ECB too much credit. Thursday’s announcement largely extends the status quo—an unnecessary move, in our view. Whilst couched as stimulus, we think it was really designed to defang a false fear: maturing TLTRO loans.

First, understand: TLTROs are not quantitative easing (QE). TLTROs let banks borrow funds for a fixed period directly from the ECB at discounted rates, providing they use them to underpin loans to businesses and consumers. This lowers banks’ funding costs, in theory. By contrast, under QE the ECB bought long-term fixed interest securities to reduce longer-term interest rates, which heavily influence banks’ loan profits. By doing so whilst fixing short rates just below zero, the ECB reduced the difference between short- and long-term interest rates (it flattened the yield curve, in industry parlance). Because banks borrow short term to fund long-term loans, this reduces profits on future lending. TLTROs do no such thing.

This isn’t the first time the ECB extended cheap funding to banks. The original version was 2011’s longer-term refinancing operation (LTRO), which didn’t require banks to lend the funds. Amid a debt crisis and recession, banks scrambling for liquidity borrowed over €1 trillion in three-year LTRO funds.[i] When LTRO repayment approached in 2014, we saw many in media fearing this would squelch lending. Hence, the ECB introduced the first TLTRO with four-year maturities, allowing banks to roll over their LTRO funds, providing they used them to underpin lending. Banks took €430 billion.[ii] In 2016, the ECB launched TLTRO-II—another four-year facility—which permitted greater borrowing at lower rates for new private sector loans. Banks not only rolled over most of their TLTRO-I funding, they increased it to €739 billion.[iii] Repayments for TLTRO-II are now poised to start coming due in the next 12 – 18 months. The ECB’s announcement it will offer two-year funding should allow banks to roll over funding once again, if they choose to.

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A Collection of Political Updates From Europe and Canada

Editors’ Note: MarketMinder Europe doesn’t favour any political party or politician in any country. Worldwide, we think political bias is blinding and leads to investor error. We assess global politics solely for their potential market and economic impact.

In our view, world politics have hit a relatively quiet stretch this month so far. There haven’t been major elections. Big legislation? Little to speak of. There is, of course, talk—a constant. However, the lack of landmark action doesn’t necessarily mean there aren’t developments worth noting. Here is a quick collection of some things we are watching, featuring the UK, Canada and Spain.

The UK Gets a New Party, Sort of

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Italy’s Recession Isn’t Likely Contagious

Italian gross domestic product (GDP)—a government-produced estimate of national economic output—fell -0.2% q/q in Q4. The dip is the second straight quarterly contraction, meeting one popular definition of a recession.[i] In the financial press we survey, this 31 January news release came with fears the eurozone’s third-largest economy will drag down the entire bloc. Yet a deeper dive suggests that may be a hasty judgment, in our view. Whilst Italy and the eurozone share some headwinds, our research shows some unique local factors made Italy more vulnerable. With those headwinds likely to fade soon, in our view, we think economic reality should surpass dreary expectations we find widespread in the media today. Expectations beating reality typically fuels rising equity markets.

Italy’s Q4 GDP contraction follows Q3’s -0.1% q/q dip.[ii] Although GDP details remain scarce, commentary from Italy’s national statistics office and companies surveyed by economic research firm IHS Markit hinted at weakness being concentrated in fixed investment, manufacturing and exports. Weak fixed investment likely resulted from Italian interest rates spiking higher during autumn’s budget standoff with the EU. The budget spat drove 10-year Italian government debt yields up to 3.6% in October from 2.8% in September.[iii] Whilst 3.6% isn’t historically high, we suspect the sharp spike may have temporarily deterred borrowing, with downstream impacts on business investment. This is doubly the case here, in our view, as the jump looked fear-driven and likely fleeting. According to our analysis, temporary rate spikes often cause businesses to delay funding planned investments as they wait for rates to subside before locking in years’ worth of interest expenses. It is sound financial management to take a wait-and-see approach before making a long-term decision. With Italy’s budget standoff now over and rates lower, firms are better able to pursue business plans, borrowing and investment they may have hesitated to undertake last autumn. In our view, this probably pushed some economic activity from late 2018 into early 2019.

We think new EU emissions standards also likely pinched Italy in the autumn. These seemed to hit Italian industrial production, which fell in all three months during Q4, dropping -0.8% m/m in December.[iv] They also apparently drove deteriorating manufacturing purchasing managers’ indexes (PMIs)—surveys estimating the percentage of businesses that grew in a given month. The new standards took effect in September, creating production problems automakers needed to solve, according to industry reports. For example, Volkswagen estimated higher standards would interrupt production of 200,000 – 250,000 vehicles in 2018’s second half.[v] Whilst Germany is more known for auto production and felt a related GDP hit in Q3 (as did Sweden), Italy is also vulnerable because many Italian manufacturers supply German carmakers. Auto sales figures hint at consumers buying ahead of the new regulations, with sales jumping before the rules took effect and falling through yearend. (Exhibit 1) This is normal when changes like this take effect, in our view, and we think it usually proves short-lived as everyone adapts to the new regime.

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Investing in financial markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid. Past performance neither guarantees nor reliably indicates future performance. The value of investments and the income from them will fluctuate with world financial markets and international currency exchange rates.

This article reflects the opinions, viewpoints and commentary of Fisher Investments MarketMinder editorial staff, which is subject to change at any time without notice. Market Information is provided for illustrative and informational purposes only. Nothing in this article constitutes investment advice or any recommendation to buy or sell any particular security or that a particular transaction or investment strategy is suitable for any specific person.

Fisher Investments Europe Limited, trading as Fisher Investments UK, is authorised and regulated by the UK Financial Conduct Authority (FCA Number 191609) and is registered in England (Company Number 3850593). Fisher Investments Europe Limited Headquarters: 2nd Floor, 6-10 Whitfield Street, London, W1T 2RE, United Kingdom. Fisher Investments Europe Limited’s parent company, Fisher Asset Management, LLC, trading under the name Fisher Investments, is established in the USA and regulated by the US Securities and Exchange Commission. Investment management services are provided by Fisher Investments.