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The well know trading adage “sell in May and go away” materialised during the last week of May as positive sentiment surrendered to political turmoil, largely emanating from Italy and Spain, leaving investors with a bittersweet taste.
What do we make of the political turmoil? Is this a return to uncertainty and renewed euro area crisis scenarios? We argue that it’s not. And that pragmatism is heeded as we reinstate our neutral views across asset class, matching our quarterly views issued back in March.
The rise of populism as a political risk is nothing new and was already on an uptrend when Tsipras became Greece’s prime minister in 2015, gaining ground with Trump’s presidential win in late 2016. Furthermore, commitment to the common currency remains intact. Despite early signs that the newly formed Italian government’s populist characteristics could post a threat to the common currency, any thoughts towards this direction were quickly abandoned when the Italian president declined to confirm the appointment of a finance minister with “Italexit” aspirations.
With US tariffs taking effect on 1 June aimed at putting pressure on export-orientated European nations, we expect Germany to provide concessions on further European integrations (EU IMF and/or Eurozone investment budget) and thus join President Macron’s vision for Europe. The investment implications would suggest avoiding Italian debt (on the basis of deteriorating public finances) but also avoiding German debt (on the basis of unattractive yield for 10-year risk in an economy that is running at full capacity). On equities and the euro, we remain neutral – albeit with a positive bias in alignment with our bullish year-end targets.
What do recent political developments in Europe mean for Brexit Britain? There are some that may argue that the European political turmoil is a good thing for the UK as the EU cannot afford to fight battles on multiple fronts. That said, the rise of eurosceptics will strengthen the position of the hardliners within Europe. Ultimately, it is in the UK administration’s hands to provide concrete proposals and a credible action plan for a sensible Brexit. More clarity is expected from the EU’s summit at the end of June. On the investment side, we continue to favour UK income stocks, UK credit and have a positive bias on GBPEUR.
Finally, turning to the US markets, the resilience of the US economy and the tight labour market continue to support a hawkish Fed and shape our neutral/negative fixed income view and positive equities view. We focus on stocks with value characteristics as this factor has lagged since the beginning of the year. Finally, we expect the US dollar to move sideways with a downside risk contingent to positive developments on the other side of the Atlantic.
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