Worries of possible political turmoil in Italy triggered a sharp sell-off in European markets today, pushing key indices, namely CAC, DAX and FTSE, down 1-2%. The vote in Italy has left the country facing a political deadlock, raising new fears over the euro zone's debt crisis.
According to Stephane Deo, global head of asset allocation at UBS Investment Bank, the downtrend is likely to continue. He tells CNBC-TV18 that the global situation is shaky right now, and that the Italian trouble is probably only the beginning. “This is the first negative news we have had – the Italian elections. We potentially have a problem in Spain coming. At some point in the not so distant future, we would probably have to turn our attention to the other side of the Atlantic to the US with the debt ceiling. So I think this is the beginning of a correction,” he explained.
However, he doesn’t expect the correction to be too sharp thanks to improving fundamentals.
Below is an edited transcript of his interview with Sonia Shenoy and Latha Venkatesh. Also watch the accompanying video.
Q: We are seeing a big savage cut across global markets. Is this just routine profit taking or is it a more deep-rooted sell off that the markets will see going ahead?
A: It’s really two things which are happening. The first thing is the market is reacting to the news in Italy. The Italians were voting yesterday and the day before and there is no clear majority about the Senate. That means that it would be very difficult to govern this country and that obviously raises the political risk in Europe. I think that’s the trigger for today’s sell off. We had a very good rally since the beginning of June so the markets are now in need for consolidation. I think we are in a shaky situation right now and the market could correct.
Q: Do you think a sharp accentuation in Italian yields could have some kind of a mollifying impact on the politics in Italy? Do you see them peaking off and returning to the table in the form of some kind of fiscal prudence irrespective of the coalition nature of the government that will come or do you think we are going to see much more weakness before that kind of sense prevails?
A: The sell off on the 10 year yield is at 4.80% right now as we speak in Italy. So for the time being it is far from a catastrophe. You have to remember that in the summer 2011 the yield went to 7-7.5% when Berlusconi had to resign. So very clearly the market is pricing more bad news and is reacting badly to the elections. But I do not think we are in the red zone yet far from that.
Q: Tactically, at this point in time, would you advice profit-taking or do you think that any kind of dip should be used as an opportunity to buy into the markets?
A: No, I think that’s a collateral damage in the sense of the Italian election. I think the political problem in Italy is not running away. We now have the result of the elections. Obviously the next step is that the President will have to name a Prime Minister after which you will enter a phase of negotiation and probably that will be very difficult.
The news yesterday is telling you that the next week or more will consist of very volatile political news and a lot of noise that will be detrimental for the Euro. So I think the reaction we are seeing now is likely to continue in the near future.
Q: So are there severe sharp cuts to come or is it time for bottom fishing? What would be your range on the Euro for the week?
A: It’s not time to go bottom fishing. This is the first negative news we have had – the Italian elections. We potentially have a problem in Spain coming. There is negotiation in Cyprus also which could be very difficult. At some point in the not so distant future, we would probably have to turn our attention to the other side of the Atlantic to the US with the debt ceiling. So I think this is the beginning of a correction. It would not be a sharp one because the fundamentals are improving, but I do think there could be further downside risk for the stock market in the near future.
Q: There are some comments that are coming in with respect to Berlusconi ruling out any kind of alliance with the other parties. In case there is a potential gridlock in Italy, what could the spiral effect be on some of these other nations like Spain?
A: The first thing is if you have a total gridlock and it is totally possible because the Senate has no clear majority. You would probably go for another election which is another period of uncertainty and you don’t know what the result of the election would be. But in terms of the collateral damage is, the main would be Spain. If you look at the spread today, Italy is widening by 24 bps on the 10 year. Another country which is widening a lot is Spain with 16 bps, Greece as well, but Greece is to some extent it is irrelevant. So Spain would be the next one by far.