Now, more than ever, Italy looks like a big, fat mess for investors.
On Dec. 4, Italian voters roundly rejected constitutional reform. The immediate impact was the resignation of Prime Minister Matteo Renzi.
He had promised to do so if the result went against him. That means at least one campaign promise has been kept. Still, the move creates other issues.
The resignation is “likely paving the way within the next few weeks for the formation of an interim government with a limited mandate,” states a recent report from Eurasia Group, which also downgraded its outlook for the country from neutral to negative after Renzi stepped down. Foreign Minister Paolo Gentiloni will replace Renzi — assuming he wins a confidence vote in Parliament as early as next week — but it’s also likely that Italy will have early elections next year.
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Whenever the next election comes there is an increasing threat of a win by populist anti-European Union factions.
“The risk of a eurosceptic Five Star Movement government emerging from the next election and in turn posing a direct threat to Italy’s eurozone membership is still low, but increasingly realistic,” states the same Eurasia Group report.
Already, Europe has seen a massive rise in anti-EU sentiment, most notably with last June’s vote for Britain to leave the trade area. Don’t rule out the anti-EU contingent just yet.
Italy’s shaky banks. As a group, these financial institutions have more than their fair share of what are euphemistically called “non-performing loans.” The more appropriate name is “bad debts,” which are having a similar effect on the Italian banks as subprime debt had on U.S. banks in the recent financial crisis — it’s weakening them.
“Given the latest developments on the matter, now it seems increasingly more likely that the Italian government will be involved in the recapitalization of the Italian banks and that this scenario might pose some concerns to investors,” says Ivo Pezzuto, professor of business economics at the Catholic University of Milan.
In short, it’s the combination of bad banks and political uncertainty that has investors concerned that the Italian problem might spread further and engulf other countries.
“One cannot rule out an avalanche developing, but policy makers will be doing their best to make sure it doesn’t,” says Andrew Milligan, head of global strategy at Standard Life Investments in Edinburgh.
The investment implications. Hopefully, the broader European economy doesn’t get a case of Italian contagion. But the matter does raise the issue of why invest in Europe at all. Italy is just one member-state of the EU and it has big problems. Other countries have their own issues.
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“The difficulty with investing in European assets is that there are so many moving parts,” Milligan says pointing to a host of issues, including national elections, policy decisions by the European Central Bank, how Turkey might choose to deal with its influx of refugees and the solvency of Italian banks. “Some are positive and some are negative,” he says.
With all investing decisions it comes down to the relative merits of the available choices, or more simply, which investments look better than others. In the end, you take the best alternative.
“Why invest in Europe? You need to do a lot of work to understand the potential negatives,” Milligan says. “The difficulty when considering Europe is that when you step back from it there are some easy ‘yesses [elsewhere in the world].”
Where? Milligan says it’s easy to like U.S. and Japanese assets.
The practical matter. On a practical level that may mean staying away not just from Italian stocks but from all European stocks and favoring those in other parts of the world. Or alternatively, it may mean trying to profit from the potential for declines in European stocks. Or perhaps do both.
“I’d be shorting European stocks and buying cyclical stocks in the U.S.,” says Victor Sperandeo, CEO of EAM Partners in Dallas. In other words, he’d sell borrowed European stocks hoping to profit from a fall in the price, and separately he’d buy those U.S. stocks which tend to fluctuate in price in line with the business cycle. Such cyclical stocks would include commodity producers and industrial companies.
A potentially dire outlook. Longer term, Sperandeo sees bigger problems for the EU. “There is no way the EU can continue,” he says. “The big question is which country will elect its version of Marine Le Pen and then opt out,” referring to the ultra-right wing nationalist politician from France.
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Many European countries have seen a rise in the popularity of right-wing nationalist parties who now threaten the political status quo. A burning question on the minds of many investors has been whether other countries will follow Britain’s lead and decide to quit the EU — and if so, how many such moves will it take to make the whole experiment collapse.
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What Italy’s Big Vote Means for Investors originally appeared on usnews.com
