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Multi-asset: European markets on the brink?

Consensus on prospects for the continent breaks down following the destabilising election in Italy

Multi-asset: European markets on the brink?

Italy’s crisis has increased political uncertainty in Europe. And this is reflected in diverging views from multi-asset fund managers on the prospects for European equities and bonds.

Ahmer Tirmizi, investment manager at Seven Investment Management, is relatively sanguine. He said Italy has always been in crisis, with more than 60 governments since the Second World War.

He expects investors to ultimately re-focus on European growth, earnings momentum and European Central Bank (ECB) policy. But he accepts it could be a volatile summer.

‘We remain overweight Europe, as valuations still look attractive versus the US, even when accounting for the higher profitability of American companies,’ Tirmizi said. ‘But we hold equity put options and US Treasuries to help mitigate the risk of a market sell-off and continue to have ongoing discussions around managing risk.’

Meanwhile Nick Watson, multi-asset fund manager at Janus Henderson Investors, is also relatively positive. He believes turmoil in Italy reduces expectations for the pace of ECB tapering and further pushes out expectations for potential monetary tightening.

‘At the end of April, the bond market priced in 0.28% of interest rate tightening in Europe until the end of 2019,’ he said. ‘This figure is now 0.17%.’

Watson says European smaller companies look interesting in this environment. ‘They have performed well in the period of quantitative easing [QE] and should benefit from the continuation of QE and from -0.4% interest rates,’ he said.

Andrew Harman, manager of the First State Diversified Growth fund, agrees political and economic uncertainties mean QE could be around for longer. But he is concerned about the ECB looking to exit QE and increase interest rates in the longer term. He thinks country specific and credit risks will increase as a result.

‘This is especially true for sovereign debt in the periphery such as Greece, Portugal, Spain and Italy,’ he said. ‘And it will also filter down to equities and corporate bonds.’

By contrast, Christopher Teschmacher, multi-asset fund manager at Legal & General Investment Management, does not expect an extension of QE. ‘We could see some tweaks to extend the maturity profile of Italian bonds being purchased but don’t expect a major overhaul,’ he said.

Pasta la vista

More worrying still, Katy Thorneycroft, Citywire + rated co-manager of the JP Morgan Multi-Manager Growth fund, warns Italy’s problems could hit consumer and business confidence. ‘At least a small dent in the European growth outlook seems likely in the near term,’ she said.

She highlights weaker European earnings growth expectations, political concerns, and the expected headwind from a strengthening euro. As a result, Thorneycroft prefers US, Japanese and emerging market equities.

‘Recent developments in Italy support our cautious stance on Europe,’ she said. ‘But we’ll continue looking for opportunities there as much of the negative news may already be priced in.’

Thomas McDonald, manager of several Russell Investments multi-asset funds, has an even darker perspective. ‘Markets may shrug off political headwinds within weeks, but the scarring to sentiment will remain,’ he said. Indeed he thinks the Italian situation has revealed the fragility of European financial markets.

Teschmacher agrees Italy’s situation could turn toxic and suggests recent developments imply a new level of political chaos. ‘As the third largest issuer of government bonds after the USA and Japan, Italy is too big to be allowed to fail: there could be severe contagion to the global financial system,’ he said.

However, Teschmacher also says it is too big to comfortably bail out using tried and tested mechanisms. ‘The size of an Italian collapse could derail the global economy. But our base case is still for relatively stable global economic growth, at least for the rest of the year,’ he said.

Investors will surely be hoping his base case scenario is correct.

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