The road to a stable government in Italy after parliamentary elections looks as bumpy as a cobblestone pavement for a Fiat Cinquecento. So is trouble ahead for the euro and Italian (or even euro zone) banks? Investors could feel tempted to kick the can down the strada and wait until the fog clears after 4 of March. Not us: We are taking a closer look at the yen and Japanese banks instead.
Duo infernale Grillo/Berlusconi?
The 4 March ballot could well disrupt the calm in European politics that has prevailed since last year’s election victory for Emmanuel Macron in France. The protest party Five Star Movement (Movimento 5 Stelle, M5S), led by former comedian Beppe Grillo, is likely to receive the most individual party votes, but will not be able to form a government without coalition allies. From a European viewpoint, a coalition of M5S with the euro-sceptic center-right camp led by octogenarian Silvio Berlusconi would be negative. If, on the other hand, an alliance was formed between M5S and Matteo Renzi’s center-left camp, the disturbance in the euro zone will probably be contained and soon calm down again. However, all larger parties (like Renzi’s Partito Democratico or Berlusconi’s Forza Italia) have so far strongly denied any openness to form a coalition with the M5S movement.
The most likely scenario at the moment, as we see it, is that the center-right coalition of Silvio Berlusconi (Forza Italia) and Matteo Salvini (Lega) could receive the most votes and thus also the mandate to form the government from President Sergio Mattarella. According to current polls, this center-right alliance could achieve a narrow majority in parliament with the center-left alliance of Renzi (grand-center coalition) and other small left and right-wing parties. However, it is doubtful whether such a coalition could hold on to power for a long time. New attempts to form a more stable government or even new elections towards the end of the year would therefore not be ruled out. Italy will probably be entering another turbulent political period.
Besides Italy, the unresolved political crisis in Catalonia is also a headache for the euro zone. We have therefore decided to swap some of our holdings in European banks for Japanese ones. There are several reasons for this. For instance, it seems that the Bank of Japan (BoJ) is slowly winning the fight against deflation. Even though the BoJ is unlikely to bring inflation up to their 2 percent target in the next two years, the trend is getting encouraging. Therefore, the BoJ may give up its zero-yield target for 10-year Japanese government bonds and let it rise to 0.3 percent in the second half of 2018. This does not sound much, but remember it was the very early stage of monetary policy normalisation that triggered a significant U.S. dollar (2014) and euro (2017) rallies. Moreover, the Japanese yen is one of the cheapest currencies worldwide. As for Japanese banks, they are attractively valued after a 30-year bear market. Taking into account earnings that continue to surprise to the upside, we believe that Japanese banks have catch-up potential. This holds true particularly if monetary policy is normalized. It is specifically the financial industry that would benefit from an environment of rising yields.
Overall, we remain neutral on equities, even after swapping a Fiat Cinquecento for a Nissan Micra, so to speak.