My favourite Brothers Grimm fairy tale concerns a fisher and their partner. In brief, a poor fisher ends up being granted wishes by an enchanted flounder. At first all goes well and the fisher family’s situation improves. But their partner makes increasingly grand requests until eventually they end up with nothing again.
Ok, it’s a good story but why is it relevant to the world right now? The first parallel to strike me is with Italy.
There, the right-wing Lega party is the fisherperson and Deputy Prime Minister Matteo Salvini their partner. Lega has been on the rise since the Italian election in March last year and is nearing 40% of the vote share in the country. This ascent has relegated Salvini’s fellow Deputy Prime Minister Luigi di Maio of the anti-establishment Five Star Movement to a more diminished role.
Emboldened by this popularity, Salvini harangued Prime Minister Giuseppe Conte until eventually he brought down the government and called for fresh elections. That’s when it went wrong for Salvini and Lega, horribly wrong. Now we have Five Star and the centre-left Partito Democratico (PD) proposing a coalition, led again by Conte, and Lega seems to have been kicked to the sidelines – at least for now.
While this is bad news for Salvini and Lega, it’s been great news for markets, which are delighted to be facing a more moderate coalition than before. Previously, Lega’s plans to cut taxes and Five Star’s commitment to more spending were particularly tough for the EU and investors to swallow.
Trade war fatigue
Italy is not alone. There are two other obvious cases where tough negotiating could lead to bad outcomes for those involved, the US-China trade war and Brexit.
Both can deliver binary outcomes and are driven by a small number of powerful main figures. As a result, our economic framework is impaired due to the high level of uncertainty around crucial policy decisions. This means that as either situation escalates, it is becoming harder for us to have high-conviction views.
In the case of trade, it feels like the market is becoming incrementally wearier with each new headline. For instance, at the start of August the S&P 500 index fell by about 5% when President Donald Trump announced a round of tariffs. Yet when he announced another, similar-sized increase later in the month, the market impact was much smaller.
All these episodes remind us of the unpredictability of politics, which is encouraging us to reduce our equity exposure gradually as markets rally. On the trade war, we feel that complacency may be setting in, given that tariffs increased on Sunday and are due to rise again in a month’s time.
In Italy, meanwhile, we’ve not bought into the rally because we felt a lot of positivity was being priced in too fast, such that if complications materialised they could lead to a larger than normal loss. Instead we focus on less-loved areas of the credit market, such as emerging markets and in some cases Greece. Just don’t call them frog princes.