In Italy, a political pairing that investors once considered a worst-case scenario is set to become the new government, yet Italian stocks continue to outperform all other major developed markets this year.
The anticipated government coalition between the hard-right League party and the antiestablishment 5 Star Movement, a combination long considered by analysts to pose a major risk to the country’s economy and the eurozone itself, hasn’t stopped Italian stocks and bonds from outperforming.
The country’s headline stock index, the FTSE MIB, is up 11% this year, well above the eurozone’s broader Euro Stoxx 50 index and the S&P 500, each up around 2%. The FTSE MIB was up nearly 14% last year.
Spreads between Italy’s 10-year government bonds and Germany’s, a widely followed measure of perceived risk, now stand at around 1.3 percentage points. That’s up marginally from last month but still comfortably below the 1.6 percentage points spread at the start of the year.
“We’re surprised the market is so benign after the events of the Italian elections,” said Giuseppe Di Mino, managing director at hedge fund Amber Capital. “We were at least expecting some volatility ahead of this new government.”
The political parties’ main economic proposals could have a significant impact on Italy’s finances, with both in favor of scrapping a controversial pension reform and increasing welfare spending. Italy’s public-debt burden is 132% of its gross domestic product, the world’s third largest.
Italy already shells out €70 billion ($84 billion) a year to service its debt, even though European Central Bank policies are aimed at keeping borrowing costs ultralow. This is all set to change later this year, analysts say, as the bank finally starts rolling back monetary stimulus.
But investors have been repeatedly wrong-footed when betting on Italy’s fractious politics in recent years. The FTSE MIB is index up 10% since the messy results of the country’s March 4 election. And Italian assets remained buoyant after voters rejected changes backed by the government in a 2016 constitutional referendum, leading Prime Minister Matteo Renzi to resign.
Indeed, many analysts are skeptical the two parties will be able to change government policy that much, at least soon.
“The populist parties have made a lot of promises that ultimately will be very expensive,” said Nicholas Brooks, head of economic and investment research at Intermediate Capital Group . And because the parties have such different priorities, it may be difficult to get anything done right away, he said.
Meanwhile, many investors have been focusing on economic growth that remains robust in Italy and across the eurozone, and on signs that the cleanup of the country’s banking sector is going well.
What once really concerned money managers was the threat of the eurozone breaking up, but that now seems a thing of the past.
The 5 Star Movement once appeared intent on taking Italy out of the zone, but later suggested this was not the time for a euro exit.
When the party said, “‘Actually, we are not in favor of breaking up the euro anymore,’ to me that was a buy sign for Italy,” said Mike Riddell, a fixed-income fund manager at Allianz Global Investors, whose portfolio is currently biased toward Italian bonds.
Also fading are concerns that high debt levels in southern European countries, like Italy, would lead to a eurozone breakup.
Between 2010 and 2012, when the bloc grappled with an economic downturn and ballooning government deficits, money managers piled into German debt while amassing large bets against Italy, Spain, Portugal and Greece. Spreads ballooned between southern European bonds and German debt.
When ECB President Mario Draghi promised to do “whatever it takes” to save the euro in 2012, spreads quickly came down and are now around their narrowest since before the financial crisis.
For many investors, that showed that southern European spreads weren’t reflecting concerns over economic performance and finances, but instead the risk that debtholders would be repaid in currencies other than euros if the ECB didn’t stand behind these countries.
“The risk of the eurozone breaking up is no longer in the market,” said Isabelle Vic Philippe, head of euro rates and inflation at Amundi, Europe’s largest asset manager.
To be sure, some analysts believe that the market is overlooking the risk of political tensions flaring up again if the eurozone economy slows and southern Europe’s budget deficits surge.
“In an environment in which interest rates start to rise globally, debt burdens start to rise, and the question is whether countries like Spain and Italy can take those higher borrowing costs,” said Craig Inches, a fund manager at Royal London Asset Management.