Is it Time to Review Your European Investment Strategy?
February 22, 2013
of Thomas White International
A sharp equity and bond market reaction is likely expected in response to the outcome of Italy’s February 24-25 general elections, several media sources such as THE GLOBE AND MAIL have reported. While the poll result is uncertain, these reports indicate that in the event of a clear victory for Silvio Berlusconi’s political party, buying interest in equities and lower-quality debt may be affected.
Portfolio implication: A life-saving operation on Italy, Europe’s fourth largest economy, shows some early positive signs, but the surgeon may be voted out of power in the upcoming election. If the patient can’t make a comeback to fair health, the Euro-zone’s members may be hard put to stay in their current country configuration and to keep the euro as their common currency. The government, now led by Mario Monti, likely needs to continue its austerity measures and structural reforms. These painful policies have enabled Italy to rebuild some investor confidence, and have allowed the country to sell its sovereign debt at reasonable interest rates. Failure to issue debt would have forced Italy to ask for a bailout from the European Union and IMF. If Italy’s current policies are abandoned, its cost of selling debt will likely surge, as in the first half of 2012. This could trigger a wave of risk aversion, affecting debt and equity investors worldwide.
Economic situation: Italy has the second largest public debt in Europe after Greece. Its economy has deep-rooted structural problems — such as falling competitiveness in the global export market largely due to an unproductive labor force. In recent quarters, the country has been mired in recession, hobbled by public spending cuts and high unemployment. Given its high debt, the Italian government relies on the sale of large volumes of bonds regularly to finance its expenses and debt-servicing costs. Hence, Italy is vulnerable to any spurt in its sovereign yields, a proxy for its borrowing costs. For example, in late 2011 and nearly all through the first half of 2012, the European crisis intensified as Italian and Spanish sovereign bond yields climbed rapidly on concerns that the two countries might need bailouts just as Greece, Portugal, and Ireland have.
Political background: In late 2011, after Silvio Berlusconi lost his parliamentary majority amid scandals and a surge in Italy’s borrowing costs, Mario Monti was appointed to head a technocratic government until scheduled general elections in mid-2013.
After coming to office, Monti implemented reforms and austerity focused policies, which were perceived to have improved international confidence in Italy but upset a large number of Italians. In fact, along with the European Central Bank’s September pledge to buy unlimited amounts of Euro-zone government bonds, Monti’s reforms are widely believed to have played a role in stabilizing Italy’s borrowing costs in the second half of 2012, as The New York Times has pointed out.
But Berlusconi’s center-right PdL party withdrew its support for the Monti government in early December. And now, Italians are going to early polls February 24-25.
What's at stake? Any political instability following the election could be potentially damaging, as reports from media sources such as the BBC and analysis by organizations like the European Council on Foreign Relations indicate. If there is a political stalemate and Italians are seen to have voted against austerity and reforms, markets may see another phase of risk-aversion and the uncertainty surrounding Europe could intensify.
Who are the main parties and leaders?
- A center-left coalition led by the Democratic Party (PD), in alliance with the left-wing SEL party. The PD is led by former Communist and ex-minister Pier Luigi Bersani.
- A center-right alliance between Silvio Berlusconi's People of Freedom and the more right-wing Northern League. The scandal-ridden and flamboyant Berlusconi has been prime minister three times previously. Berlusconi has suggested he would not be prime minister again but that PdL Secretary Angelino Alfano would lead the government should the alliance win the elections.
- A centrist coalition led by Mario Monti. This includes Monti's own list, Civic Choice with Monti for Italy, the Christian Democrats and a smaller center-right party, Future and Freedom for Italy. Monti is a senator-for-life in the upper house and so is not standing for election personally. He is however able to take a full part in the campaign and could return to the post of prime minister if the centrist coalition that he leads proves successful.
- The Five Star Movement (Movimento 5 Stelle or M5S) is an anti-establishment citizens' movement which has done very well in recent regional polls, and is the brainchild of outspoken satirist and blogger Beppe Grillo. It is a wild card in the electoral pack. Grillo leads the movement but is not running for election himself.
Berlusconi has promised to reverse Monti’s austerity steps and introduce tax cuts if returned to power. Bersani has announced that if elected he would continue Monti’s reforms agenda as well as take additional steps to promote growth and job creation.
Likely post-poll scenarios and their market impact
According to Italy’s rules, poll surveys were allowed until February 9. CNBC.com has reported that a median of polls published before that date give the center-left leader Pier Luigi Bersani and his PD party a 5.7-percentage-point lead over Berlusconi's PdL party. Beppe Grillo's 5-Star Movement is in third place and Monti's bloc in the fourth.
In fact, Bersani’s center-left coalition consistently led the opinion polls (for the lower house vote) during the campaign, though Berlusconi succeeded in reducing that lead.
If the center-left coalition comes to power on its own, its leader Bersani is expected to continue reforms, as he has promised. This may assuage investors concerned about the continuity of structural reforms in Italy.
If the center-right alliance forms the government with or without Berlusconi as prime minister, investors may begin worrying again about Italy’s commitment to carry out reforms and improve its fiscal situation.
A deadlocked result may lead to short-term uncertainty. But as political commentators have speculated, if the Monti bloc helps the center-left group led by Bersani form a coalition government, markets may perceive it to be a positive outcome of Italy’s election.
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