Stewart Robertson, Senior Economist at Aviva Investors looks at the upcoming Italian elections and how their potential outcomes could influence Italy’s capital markets and investors exposed to them:
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“The Italian elections could either calm or spook Italy’s financial markets. The complicated two-tier electoral system means there is a very real risk of an inconclusive outcome: the Chamber of Deputies with its 630 seats should produce a clear result by design – the winning party is assured of a majority of seats. But the 315 seat Senate is elected on a regional basis. There is a real likelihood of no overall majority.
“Arguably this has partly led to the stock market now being flat and 10-year Italian sovereign bond yields increasing 30 to 50 basis points this year alone, meaning bond prices have dropped following decreasing demand from investors. With the Italian bond market being the third-largest in the world*, the choices that Italy makes will have a material impact far beyond its own borders.
“In our opinion, the most market-friendly result would be a win for the centre-left democratic party (PD) led by Pier Luigi Bersani, especially if it formed an alliance with the centrist Civic Choice party led by outgoing technocratic prime minister, Mario Monti. The two more unwelcome outcomes are an inconclusive result that leads to political stalemate and the likelihood of another round of elections, or a result that involves the return of the centre-right and Silvio Berlusconi. This could slow reform progress and spook investors.”
Robertson, together with Aviva Investors’ asset allocation team headed by Mirko Cardinale, identified four possible election outcomes, their probability and likely market movements:
Probability: 40%
Election outcome:
A win for the centre-left but one that relies on a coalition with Monti’s centrist party
Description:
Easily the most market-friendly result with the combination of an administration acceptable both at home and in the rest of the Eurozone. This should be the most credible government and one that would maintain and build on the progress Italy has already made towards reform and fiscal consolidation.
Market movement:
Italian bond yields down 25-40 bps
Italian stock market up 3 – 5% or more
Probability: 30%
Election outcome:
An inconclusive result, with no overall majority and no easy coalition possibilities
Description:
This scenario could unfold in a number of ways but the most likely is no overall majority in the Senate and no mathematical way of linking the centre-left with the centre or of the centre-right forming alliances to give them overall control. This stalemate would probably require a second round of elections. In the interim, volatility in markets would be heightened.
Market movement:
Yields up 40 bps or more
Stock market down 5% or more
Probability: 20%
Election outcome:
An outright win for the centre-left
Description:
This result should produce a strong and stable government which should calm markets, but the inclusion of smaller, more extreme left-wing parties and associated reliance on Italy’s powerful trade unions could slow the reform progress, especially in labour markets. Likely to be better received by bond than stock markets as centre-left is seen as loyal to Europe.
Market movement:
Yields fall 10-20 bps
Modest stock market gains Stock market down 5% or more
Probability: 10%
Election outcome:
A majority for the centre-right
Description: This is the most unlikely outcome but cannot be ruled out. Normally a centre-right administration is viewed as business- and market friendly. Likely to spook bond markets more than stock markets, where tax cuts provide some offset. But the baggage that comes with Mr Berlusconi and the failures in reform programmes under
Market movement: Yields up 10-30 bps or more
Stock market down 2% or more
Source: Aviva Investors as at 18.02.13. The possible election outcomes should not be viewed as indicating any guarantee of return nor as advice of any nature.
