The 2016 Brexit vote reminded investors that global markets dislike uncertainty. Does this weekend's Italian election have the potential to disrupt markets in a similar manner?
Brexit redux? Perhaps not this weekend.
There is, however, a political event Sunday—the Italian election, in which voters head to polls to elect a new government.
The global fallout from the June 2016 Brexit vote, when the majority of United Kingdom voters decided in a referendum to withdraw from the European Union (EU), has some analysts reminding investors to beware of the potential election impact on stock and currency markets. Uncertainty has rarely been a friend to global markets, and this weekend's vote in Italy is loaded with it.
“Elections create uncertainty—particularly European elections—as market participants try to anticipate what a leadership change might look like,” said JJ Kinahan, Chief Market Strategist, TD Ameritrade. “There is already much uncertainty in the eurozone due to Brexit, and anything further has the potential to upset a quickly growing but somewhat fragile economy.”
The Italian election is rife with potential issues, ranging from Italy’s fragile economy to immigration. A handful of colorful candidates are campaigning, including Italy’s past prime minister, Silvio Berlusconi on behalf of the Forza Italia party. Plus, Italy is testing a new voting system, and polls have shown many remain undecided.
Investors may want to consider recent media reports citing polls that the populist, anti-European Union Five Star Movement (M5S) is likely to emerge as the single largest party from the Italian election. Anti-Europe often means “anti-euro,” raising questions about potential impact on the common currency should this party gain power. Other reports say polls suggest the results could end in a hung parliament in which no one party wins. But remember history’s take on Italian polls: they’re notoriously wrong.
Italy is the third-largest economy in the eurozone, and its economic troubles have persisted. The International Monetary Fund puts government debt at 120% of gross domestic product, compared with 45% in Germany and 82% in the U.S., CNN reported. Earlier this decade, Italy’s economic struggles factored into instability in U.S. and European markets. Bond yields in Italy rose above 7% in 2011, but hover near 2% today. Any resurgence of Italian bond yields could again raise fears that the EU might have to bail out the country.
Though many analysts don’t forecast particularly grim consequences from the Italian election— nor do markets seem to be expecting a dire outcome (see figure 1 below) — they have cautioned investors to be mindful of risks. In a widely quoted note to clients, UBS’ global research team said it has not factored in macro or political shock overall, but said it “cannot fully rule out tail risk, which could trigger 10%-15% downside for Italian equities relative to Europe.” A “tail risk” is the risk of a major market move based on an unlikely but highly impactful event — the Brexit impact on markets is a recent example.
FIGURE 1: HOLDING ITS OWN.
Despite the potential for political change, the Italian benchmark FTSE MIB Index has tracked closely to a broader-based European index, the Euro STOXX 50 (purple line). Data source: FTSE Russell Indexes, Deutsche Börse Group. Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.
In Europe, analysts said brokers are raising margin calls for certain assets ahead of the Italian election. That, in itself, is not necessarily unusual in Europe as a means of managing risk amid uncertainty.
The euro has been down from mid-February highs vs. the dollar, but not much. As of March 1, it was trading near $1.22, down from nearly $1.25 on Feb. 14, its last peak. A year ago, it was down around $1.05, its lowest level in more than a decade.
U.S. investors might want to watch for any possible election-related weakness in the euro, in part because it could ricochet to U.S. companies selling products overseas. In 2016, the U.S. sold $270 billion worth of goods and $231 billion in services to the EU, according to the U.S. Trade Office. That made the EU the U.S’.s biggest export market.
Elections have consequences, but generally markets these days seem less focused on voting and more on central bank moves. That could conceivably help blunt the market impact of any surprise Italian election results. Still, it’s always wise to be prepared when uncertainty looms.
“If election results really upset the eurozone and stocks sell off sharply, the security blanket is that it might mean the European Central Bank (ECB) won’t back away from easy monetary policy,” said Patrick O’Hare, chief market analyst at Briefing.com. “There could be short-term dislocation and it may look unnerving, but if people start to think it will convince the ECB to hold off on tightening policy, that could help things settle down,” he said.
Conversely, if the election results lend credence to fiscal unity in the eurozone, it could clear some uncertainty from the table, O’Hare said, adding that such a result might make the ECB feel more comfortable about moving away from easy monetary policy. “The market’s perspective is related to central bank policy, and that will dictate the direction of the markets after the dust settles from the election,” O’Hare said.
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