Andrew Morris, managing director of Signature, the arm of Rowan Dartington dedicated to supporting investment professionals and their clients, comments on the crisis facing the Italian bond market…
We are experiencing a seemingly relentless rise in the EU government bond yields of Greece, Portugal, Spain and Ireland. Are we to be joined by Italy, a country which whilst being frequently mocked for the state of its public finances had until recently escaped the attention of the bond markets? The omens aren’t good. The Italian bond market is the third largest in the World. Estimated at EUR1.6 trillion – three times the size of Spain’s. Given that it is also one of the largest economies in Europe this is a completely different proposition to the problems of Greece, Ireland and Portugal. Italian banking shares fell hard last week, with Unicredit alone down 20%. This uncertainty has the potential to lead to further selling pressure across the pan European banking sector.
At first glance the contagion within EU debt seems restricted to the usual suspects of Greece, Ireland and Portugal. However, the sharp narrowing in the differential between Spain and Italy over the last month gives a clear indication of the markets jitters. Not only is the size of the Italian borrowings an issue, but the fact that Italy still needs to raise half of its total funding requirement of the EUR222 billion for the year.
The dithering and inaction by Euro zone policy makers is now becoming untenable and one must now wonder how much longer policy makers can maintain the illusion of control over a situation which they have plainly been behind the curve since the start. Herman Van Rompuy, the president of the European Council, met with other European leaders yesterday, including the European Central Bank President Jean-Claude Trichet, along with a meeting of the 17 euro zone finance ministers. The gatherings have been described as a ”coordination, not a crisis meeting", and apparently Italy was not on the agenda. Following the downgrade of Portuguese debt to junk status last week, the ECB now has hundreds of billions of Euros of junk bonds on its balance sheet; let us hope that Italian sovereign bonds do not join this small but growing group.
It is reassuring that in spite of these events the FTSE 100 remains close to its twelve month highs. With equities inexpensively rated, the case for shares remains intact. In addition, given the distinctly unpalatable appearance of Government finances the appeal of a corporate with a strong balance sheet and robust cash flow dynamics, appears somewhat alluring.
We remain very alert to issues faced by the global economy. We are conscious of a modest uptick we are seeing in profit warnings although this is being countered by an apparent increase in corporate activity. Therefore, our investment strategy remains highly selective in terms of the exposures we have in our investment universe. By way of illustration we have very little exposure to the UK high street reflecting our pessimistic view of the UK consumer outlook. Likewise we are adopting a cautious stance to our banking exposure.
