The price movements of Italian Government securities (BTPs) in the past week have demonstrated once again that financial markets can change rapidly.
The chart below shows the price of the Italian 10-year bond future. Having traded on a gently sloping upward trend for most of the last year, the release of an initial draft of the agreement between the two largest elected parties, Five Star and League, caused BTP bond prices to plummet. Having nearly touched a cash price of 140 on the 4th May, BTP futures traded as low as 131.58 on the 21 May, a fall of nearly 8.5 points or just over 6%.
It is fair to say that there has been a sense of panic in the air. Investors have scrambled to reduce risk as the spending implications of the new government has naturally caused concerns over the future dynamics of the debt load of a country which is already very heavily laden. Although some of the more extreme measures that surfaced in the initial leaked release have been watered down or removed, investors remain wary of the program proposed by the new administration, including whether rating agencies will act to reduce the credit rating of the sovereign. Layered over this is the unease over the proposed new (and very politically inexperienced) premier and how the dynamic between the two elected parties and the premier will evolve as well as how well the new Italian administration can work within Europe.
An obvious question is how investors should think about and position themselves within such an uncertain environment? It is unfortunate that there are no easy answers, in such a volatile environment it is easy for an investor to take a position only for that to reverse against him or her or for sentiment to change rapidly as headlines surface. Experience has taught me that it pays to sit through volatile trading sessions and then take a view once a market has closed for the day. As an investor, you need to judge how the market is positioned and attempt to gauge how much selling pressure may come through. In this sort of environment, I tend to wait for a close to ascertain if the market has stayed within previous trading ranges and if not then generate tickets to transact if the market continues to trade lower than that day’s close. Over the past week, this is exactly what I have been doing, reducing risk when important technical levels have been reached.
For now, the market looks a bit more balanced than it has over the past couple of days and we wait to see if it has found a new lower clearing level that may provide some consolidation. Of course, the headlines can change, a market friendly Finance Minister would be helpful as would a more balanced approach to the desired spending. My general view is one of optimism rather than pessimism and I am hopeful that BTP prices can recover from here. The future though is uncertain so I will continue to invest in the market in a controlled and disciplined manner.
David Simner, Portfolio Manager at Fidelity International