You can’t be given a bloody nose twice

The vote ‘no’ to Italian constitutional reform in this Sunday’s referendum has cost the Italian prime minister Renzi his job and perhaps thrown the Italian government into turmoil. Markets are however not in turmoil. The euro is close to unchanged, having fallen modestly after the referendum result. European equity markets are sharply higher this morning. While Italian 10y government bond yields have breached 2%, this increase in yields is notably less sharp than at the time of Trump’s election. Investors who panic sold after Trump and Brexit have been reconditioned (correctly in our view) to not immediately re-price risk on the back of specific political events.

Instead, we view the underlying dynamic as that of policy uncertainty due to the growth of populism. This is also linked to voter concerns in respect of central bank policies driving asset prices ever higher as robust economic and wage growth remain distant prospects. In this context, medium-term market or economic risk does not in our view materially change following each specific political event.

Populism is now an accepted part of the investment landscape. If Brexit was the EU’s bloody nose and the blow from the Italian referendum added to the pain, the market action today demonstrates the shock value for investors has now diminished.

On the other hand, investors should pay close attention to Trump’s calls over this weekend to impose tariffs on companies off-shoring production from the US. Over the last decade, US investors have become unused to such specific demands to protect jobs at the expense of profits. Furthermore his foreign policy manoeuvres in respect of Taiwan and Pakistan are disconcerting.

Developed market investors take for granted sophisticated and optimal (in a game theoretic sense) diplomatic and trade policy initiatives. After Trump’s promising start, which focussed on the relatively uncontroversial need to invest in US infrastructure, the switch to some of the more controversial campaign proposals is ultimately unlikely to be as well received by global markets, even if buried by bad “news” from Italy this morning.