26 February 2020
In credit markets, investors have moved from “buy everything, because ECB is buying too” towards “I need to sell, please call the ECB and see if they can take my bonds”. Only those assets perceived to be the safest, such as German/Dutch government bonds, have performed well, prompting questions as to whether European financial policymakers will respond as they have in China and elsewhere in order to avoid recession.
Spotlight on Italian debt
European fixed income investors are focused on Italy, both because of the scale of the outbreak there and because of the potential damage to an already fragile economy with high debt levels. Veneto and Lombardy, the first two regions affected, are home to many Italian exporters and together account for more than 30 per cent of Italian GDP, meaning there will be a hit to H1 2020 growth. If the situation escalates and Italian policy action is delayed or proves insufficient, the risk of an Italian government coalition collapse increases.
Italy is exposed to China via both manufacturing and tourism, and both sectors face decreased activity in 2020. Italian firms exposed to domestic discretionary demand could also suffer if their local supply chains are disrupted. Any slowdown could impact the ability of the banking system to reduce its non-performing loan stock, increasing the cost of risk in 2020 and affecting earnings.
Leverage deepens European sell-off
In equity markets, shorter term investors had an elevated risk appetite just before share prices fell and net leverage on such trading had been high. This made the ensuing sell-off sharper than it might otherwise have been. Mutual fund trading flows have dropped off. Potential buyers are preferring to stay on the sidelines, curbing demand for some single name securities.
Further announcements about the spread of the virus in Europe will continue to weigh on markets. At these levels, markets appear to be pricing in that the virus will spread across Europe, though not yet to the US. US treasury yields have already tightened considerably in recent days as more cases have emerged across the world.
Fiscal response needed
Investors expect central banks to come to the rescue. However, monetary policy is already loose. In Europe, a 10-20bps rate cut, or upsizing of the European Central Bank’s quantitative easing programme, is unlikely to boost market sentiment in the short term. If people are not going out and spending money because they are locked in their house, central banks are ineffective.
Instead, Europe needs fiscal stimulus. While this could take time to organise, the more widespread this outbreak gets, the more likely it is that European governments will spend, especially given recent encouragement to do so by ECB president Christine Lagarde.
Fiscal policy can be very effective, but it has to be proactive, timely and well implemented. The EU may loosen the fiscal rules for Italy, and provide emergency funding. It is difficult to estimate what impact fiscal measures might have on growth, but it is unlikely to have significant implications for inflation and rates. Looking more widely, any fiscal stimulus implemented by Asian countries might also help the European economy, if European governments are more reticent to spend.
In such an environment, investors need to be cautious and maintain a bias towards quality companies that can weather the storm and have alternative supply chain routes to call on. However, over the longer term, we expect that Europe - like China - will get the outbreak under control and follow Asia down the path of more aggressive fiscal stimulus. If that happens, we could see a sudden rush of opportunities emerge as deferred demand resurfaces. Progress of the virus and counter-measures over the next couple of weeks should give a lot more clarity. Markets are reacting to greater uncertainty as much as they are to greater economic damage.
This document is for Investment Professionals only and should not be relied on by private investors.
This document is provided for information purposes only and is intended only for the person or entity to which it is sent. It must not be reproduced or circulated to any other party without prior permission of Fidelity.
This document does not constitute a distribution, an offer or solicitation to engage the investment management services of Fidelity, or an offer to buy or sell or the solicitation of any offer to buy or sell any securities in any jurisdiction or country where such distribution or offer is not authorised or would be contrary to local laws or regulations. Fidelity makes no representations that the contents are appropriate for use in all locations or that the transactions or services discussed are available or appropriate for sale or use in all jurisdictions or countries or by all investors or counterparties.
This communication is not directed at, and must not be acted on by persons inside the United States and is otherwise only directed at persons residing in jurisdictions where the relevant funds are authorised for distribution or where no such authorisation is required. Fidelity is not authorised to manage or distribute investment funds or products in, or to provide investment management or advisory services to persons resident in, mainland China. All persons and entities accessing the information do so on their own initiative and are responsible for compliance with applicable local laws and regulations and should consult their professional advisers.
Reference in this document to specific securities should not be interpreted as a recommendation to buy or sell these securities, but is included for the purposes of illustration only. Investors should also note that the views expressed may no longer be current and may have already been acted upon by Fidelity. The research and analysis used in this documentation is gathered by Fidelity for its use as an investment manager and may have already been acted upon for its own purposes. This material was created by Fidelity International.
Past performance is not a reliable indicator of future results.
This document may contain materials from third-parties which are supplied by companies that are not affiliated with any Fidelity entity (Third-Party Content). Fidelity has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content.
Fidelity International refers to the group of companies which form the global investment management organization that provides products and services in designated jurisdictions outside of North America Fidelity, Fidelity International, the Fidelity International logo and F symbol are trademarks of FIL Limited. Fidelity only offers information on products and services and does not provide investment advice based on individual circumstances.
Issued in Europe: Issued by FIL Investments International (FCA registered number 122170) a firm authorised and regulated by the Financial Conduct Authority, FIL (Luxembourg) S.A., authorised and supervised by the CSSF (Commission de Surveillance du Secteur Financier) and FIL Investment Switzerland AG. For German wholesale clients issued by FIL Investment Services GmbH, Kastanienhöhe 1, 61476 Kronberg im Taunus. For German Institutional clients issued by FIL (Luxembourg) S.A., 2a, rue Albert Borschette BP 2174 L-1021 Luxembourg.
In Hong Kong, this document is issued by FIL Investment Management (Hong Kong) Limited and it has not been reviewed by the Securities and Future Commission. FIL Investment Management (Singapore) Limited (Co. Reg. No: 199006300E) is the legal representative of Fidelity International in Singapore. FIL Asset Management (Korea) Limited is the legal representative of Fidelity International in Korea. In Taiwan, Independently operated by FIL Securities (Taiwan ) Limited, 11F, 68 Zhongxiao East Road., Section 5, Xinyi Dist., Taipei City, Taiwan 11065, R.O.C Customer Service Number: 0800-00-9911#2 .
Issued in Australia by Fidelity Responsible Entity (Australia) Limited ABN 33 148 059 009, AFSL No. 409340 (“Fidelity Australia”). This material has not been prepared specifically for Australian investors and may contain information which is not prepared in accordance with Australian law.
ED20 - 045