Europe bulls could eye UK on political shocks

UK equities could be a beneficiary of Spanish and Italian political turmoil, despite investors playing down existential risk to the European Union from the peripheral economies.

Europe bulls could eye UK on political shocks
Fighting bull picture from Spain. Black bull


Fidelity International head of multi asset Bill McQuaker lists the UK alongside the US as the equity markets best protected from volatility in the eurozone.

In Spain, prime minister Mariano Rajoy is facing a vote of no confidence on Friday over corruption convictions against 29 people connected to his party, Partido Popular.

Italy cobbled together a government late Thursday night after sending markets into turmoil this week when it appeared fresh elections were on the table. Its president rejected the coalition government’s proposal for finance minister, who was planning to introduce an alternative currency to the euro, despite not campaigning on that mandate.

McQuaker says: “The UK doesn’t have any of the euro problems, we can create our own monetary policy, we’ve got a market that’s really quite cheap and desperately under-owned by overseas money. The make up of the UK stock market, particularly the big stuff, has a lot of dollar exposure.”

The US equity market is where investors turn when trouble erupts elsewhere, he adds.

The UK has been one of the stock markets least sensitive to European bond yield spikes over the last 10 years, says Rathbones head of asset allocation Ed Smith. The US, Canadian and Korean markets are also less sensitive, Smith says.

The yield on 10-year Italian government bonds rose approximately 70 basis points this week to a four year high.

Smith says: “The gap between UK valuations and other markets is unusually wide. Clearly that is about international investors ditching the UK because they don’t want to worry about Brexit. That potentially provides a valuation cushion.”

Rathbones is underweight Europe and neutral on the UK market, albeit pessimistic on the economic outlook.

McQuaker has been underweight Europe since the end of 2017.

“That was about the risks surrounding global growth momentum, but it means I’m less troubled about these political developments than some investors are,” he says.

Spanish eyes pro-EU party

While Italian and to a lesser extent Spanish uncertainty have rattled markets, investors have played down the existential risk to the European Union or the single currency.

In the case of a no-confidence vote in Spain, Rajoy will be replaced by opposition leader Pedro Sánchez, who heads the centre left party Socialists Party (PSOE), followed by fresh elections later in the year.

Smith says Ciudadanos, the centre-right party leading current polls, is not a Five Star or League equivalent, instead describing it as a “centrist party with new ideas and firmly pro EU”.

“They’re not the sort of party that are going to tear up the fiscal rule book, piss off Brussels and cause themselves to be booted out of the euro club to the devastation of markets,” he says. “A lot of people are worried about Rajoy potentially being unseated. We don’t think it’s anything to worry about.”

Rajoy’s   exit could lead to a stale-mate with a lack of government, according to Newton Investment Management head of fixed income Paul Brain. Brain said they are not expecting significant widening of Spanish bonds over Germany. He said a caretaker government can be positive for markets because budgets are not changed.

Syz Asset Management CIO Fabrizio Quirighetti said they added to Spanish five-year government bonds on Tuesday in their euro fixed income funds. “As far as Spain is concerned, we think the current political uncertainties, not at all related to any anti-euro sentiment, just arrived at a bad time.”

The Swiss asset manager is neutral on Spain and has “very low” exposure to Italian government bonds.

Euroscepticism overdone

Miton European Opportunities fund managers Carlos Moreno and Thomas Brown said Italians are overwhelmingly pro-euro and an exit from the currency was extremely unlikely.

Despite its Italian overweight, the fund is up 2.6% over the last month.

Franklin Templeton Investments head of European fixed income David Zahn  says the Five Star and League parties in Italy were not elected on an anti-euro ticket but as a parties calling for reform in Europe.

However, Smith noted Italian voters have a higher proclivity to back populist or “economically misguided” candidates. “It’s got a very low proportion of its workforce with undergraduate degrees, its got very poor social benefits. All these sorts of things that we know from the social sciences literature tends to increase support for dangerous governments getting in.”



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