Submitted by Bill Blain of Mint Partners
Blain’s Morning Porridge – May 22nd 2018
“Kid you good-a looking, but you don’t know what’s cooking till you Mambo Italiano.….“
Yesterday saw about the least convincing massive upside rally ever – as stocks gapped higher on the open, buoyed by the outbreak of peace in the China/US trade war. Then they range traded through the day on tiny volumes. My chartists on the equity desks are utterly sceptical. There was nothing in yesterday’s action to suggest anything has really changed – and the cold trade war with China remains on. The jury is out on whether Trump just lost this round without landing any significant punches. Ding, ding, seconds out as China comes out swinging, and essentially untouched.
Oil prices collapsed 60% from June 2014 ($100) to Jan 2016 ($41). Since then are up 94% to near $80 this morning – a 4-year high! Go figure what that might mean for global growth?
Not so sure why the dollar stalled y’day. The critical rate to watch is the 10-year Treasury around 3.06% - the rules of financial gravity should mean every spare penny, cent and yen on the planet is being sucked into the only positive real yield in the bond markets, thus pushing the dollar higher as global investors are forced to buy the greenback. Maybe it’s the Trump effect again? Unconventional to see higher rates, rising fiscal policy and a tumbling currency – but it makes a curious kind of sense.
The Italian 10-year bond yield has risen 31% in the last two weeks to 2.37% – that would normally be a sign of imminent disaster. But, maybe it’s an opportunity? Markets always overweight bad political news through a process of negative bias confirmation. Bad news gets headlines, headlines attract readers, readers believe what they read – therefore every single negative thing you read about Italy reinforces the picture and 100% nailed on certainty that Italy is going to hell in the proverbial handbasket.
This morning, the new Government’s “Contract for A Government of Change” is scaring the bejesus out of everyone. Fiscal prudence is out the window - apparently. I’m reading a stack of analyst reports about increased political instability likely from the coalition, others drawing parallels with Greece, talk of referendums, and that we can expect the Bund-BTP spread to gap dramatically wider.
Have these folk forgotten the Golden “do whatever it takes” Rule and the Draghi Put?
(Speaking of the Draghi Put – some analysts are suggesting it may longer exist? They say 2.4% Italian yields will confirm the ECB has washed its hands…) That is Heresy! Of course The Draghi Put lives.. without it Yoorp will vanish in a flash of logic and blue smoke…)
I doubt it will get so dramatic. The lessons of Greece and the “Adults in the Room” scenario had a very different base – small country, very broken, no choices. Italy is a very large economy, and front and central to Europe. Its core. While Greece was a destabilising noise from the outside on a Richter Scale of 6-7 (still enough to crack the foundations), a similar Italian scenario would be a full tectonic force 10 Super-quake right in the centre of Europe – it could send the whole edifice tumbling.
It simply isn’t going to happen. Brussels won’t let it. Neither will Italian politicians – they may play fast and loose, but they know how to spread the jam. Talk about Italy will shake, rattle and roll markets and present opportunity in coming weeks – but there will be an implicit accommodation where the ECB keeps buying and behind the scenes horse-trading makes the new government look like good Europeans. Brussels and Rome will trust each other as far as they can throw each other – but it’s an alliance that pays dividends. The League certainly know that for all their hostility and posturing, Northern Italy is a clear Euro winner, and Southern Italy is a client state of European aid.
There is political risk – since 1945 Italian governments have averaged about 15 months. If there are further elections – which could be likely given the coalition’s thin legislative majority - its likely to populist drift will accelerate, raising the prospect of further instability and damaging talk about Italeave and referendums. The balance of probability is that it’s more likely we’ll see long term accommodation with the new Italian regime. They will get away with new aggressive anti-immigration policies, confirming Europe’s borders are closing.
My conclusion – for what its worth – is the Draghi Put, the threat of Italian instability contaging other states, and the maintenance of the European dream at any cost, mean Italian bonds look cheap because the ECB has to act.
Stocks – I’m unconvinced. Reform on Italy isn’t going to happen in a gridlocked system. Italy will remain the classic Sick Zero-Growth part of Europe Brussels would rather not talk about.. Pretend and pretend some more.
Meanwhile, I note the Italians are once more talking about promissory notes to pay off state suppliers – Mini-Bots! Another source of opportunity perhaps if they trade at the kind of discounts we’d expect?
Out of time and back to the day job!