Capital Markets Update: May 2018

For professional advisers only. Not to be relied upon by retail investors.

Capital Markets Update

  • Italian upheaval unsettles markets
  • Pain in Spain
  • Trade tariff tribulations

In a nutshell

Investors appeared to weather May’s storm of political upheavals in Italy and Spain, along with the potential impact of proposed US trade tariffs. UK and major global equities continued to rally. However, at the end of the month investors reaffirmed the safe haven status of government bonds as they sought shelter from bond market volatility in the wake of the events in Italy.

May’s news – Italian upheaval unsettles markets

Italy’s coalition Government was formed when the Five Star Movement finally settled on an unlikely alliance with the far right Lega Nord (the Northern League), leaving the market to react to the chaos and uncertainty that ensued. But the coalition almost fell at the first hurdle as the parties argued over who should lead it. Markets were worried about the prospects of another election given the potential that it might lead to an outright majority for one or other of the populist parties. A coalition is viewed more favourably on the assumption that it will be less effective and therefore less disruptive.

The proposal of a strongly Eurosceptic candidate for Economic Minister was rejected by the current Italian President, once again sparking fears that the coalition might collapse. The subsequent appointment of the more euro-friendly Giovanni Tria managed to calm markets down. But the coalition seems intent on conflict with the European Union (EU). This is most evident in its fiscal policy, which flagrantly flouts the current fiscal rules and will put it on a collision course with the rest of Europe.

Italy wants to roll back pension reform and if the coalition has its way, the country with the highest life expectancy could soon have the lowest official retirement age in Europe. In addition, Five Star campaigned on establishing a basic citizenship income of €780 per month to help Italy’s poorest and unemployed, which would put a strain on public finances. While the Northern League is looking to reduce the tax take by introducing a flat rate of income tax of 15-20%. It looks like a concerted effort to break Italy’s finances. A lack of fiscal discipline and the threat of ‘Itexit’ will put pressure on Italian bonds, banks and its economy.

Pain in Spain

In Spain, incumbent Prime Minister Mariano Rajoy lost a vote of no confidence and was replaced by Pedro Sanchez, leader of the opposition Socialist Workers’ Party. Sanchez has his work cut out though. He leads a minority Government, which will make any plans for radical change difficult to implement. He will support Rajoy’s austerity budget and will still have to wrestle with the separatists in Catalonia and the Basque region. However, Sanchez is looking to initiate change and make his mark, starting with the appointment of 11 women in a cabinet of 17 members.

Trade tariff tribulations 

Concerns over US President Donald Trump’s foreign policy initiatives, particularly over trade, may have taken a back seat during May but they haven’t gone away. The threat of tariffs on steel and aluminium imports still hang over the heads of traditional US allies. Only South Korea has managed to avoid the imposition of a 25% tariff on steel. Europe and Canada are in an amnesty period but that is due to run out soon with no deals negotiated. The threat of a trade war remains even though it is hard to believe that it will actually happen, particularly given how much the US is set to lose.


Market volatility remains but equity investors have, in the main, looked through May’s geo-political upheavals. Both UK and major global equities continued on their upward trajectories, in sterling terms, despite trailing off towards the end of the month. Emerging markets fared less well. In the wake of Italian political uncertainty, US, UK and German government bonds confirmed their safe haven status, with prices rising as investors reduced their risk exposure by looking for safety at any price.

Despite all the market ‘noise’ there has been little in terms of actual market movements to shift our current view. We retain an element of caution but still believe that the equity bull-run has some life left in it. The US Federal Reserve continues to manage its unwinding of quantitative easing measures designed to boost economic growth, and it looks as if the current projected path of US interest rate rises remains on course. Meanwhile, the huge fiscal stimulus in the US through tax reform is starting to come through. This combination is supporting a more positive view on the short-term prospects for US equities. However, the uncertainty around trade introduced by Trump’s planned tariffs is weighing on investor sentiment. The prospect of a trade war may appear unlikely but cannot be ignored.

Brexit appears to be taking a softer shape, which should help sterling and improve investor sentiment towards the UK. We expect things to quieten down a little in Italy over the coming months, but the new coalition’s distaste for bank bail-outs exposes Italian banks a little. A confrontational Government budget in September could put real pressure on Italian bonds and, by association, their banks and ultimately the country’s economy. How that potential conflict is contained is likely to have a big influence on the wider Eurozone.

Oliver Wallin, Octopus Investments


t: +44 (0)20 7776 3153

Important information:

For professional advisers only. Not to be relied upon by retail investors. The value of an investment, and any income from it, can fall or rise. Investors may not get back the full amount they invest. Past performance is not a reliable indicator of future results. Personal opinions may change and should not be seen as advice or a recommendation. Issued by Octopus Investments Limited, which is authorised and regulated by the Financial Conduct Authority. Registered office: 33 Holborn, London, EC1N 2HT. Registered in England and Wales No. 03942880. Issued: June 2018. CAM07119.