An inconclusive election in the eurozone’s fourth largest economy hit global markets hard, helping to force the ‘correction we had to have’. Aleks Vickovich reports
With Ancient Rome as its heritage, it’s little wonder Italian politics is often dramatic and unpredictable. However, the Romans did not face globalised financial markets and these days, the flow-on effects from political instability can be a little more widespread.
On February 9, Bank of Italy chief Ignazio Visco gave a speech to a conference in Bergamo in which he anticipated the investment world would be watching the Italian election – and its potential impact on Italian monetary policy and European financial markets – with bated breath.
“Italy must not lower its guard,” Mr Visco said. “The attention of international investors continues to focus, rightly, on our capacity to preserve balance in public finances and to pursue with determination, an increase in our development potential.”
Not only were investors paying attention but they didn’t like what they saw. As exit polls started to flow in from voting booths across the ‘boot and ball’ – many of them showing better-than-expected results for former prime minister Silvio Berlusconi’s centre-right coalition – Italian shares and bonds lost earlier gains.
The final results were inconclusive, with the centre-left coalition led by Pier Luigi Bersani winning a majority in the lower but not the upper house, and a strong showing for the protest Five Star Movement party.
It’s possible that another election will need to be scheduled.
Described by Douglas J Elliott of the Brookings Institution, a US think tank, as a “triumph for fantasy and irresponsibility”, the election results triggered panic, with global investors fearful the poll result – or lack thereof – could lead to a renewed snowballing of the eurozone crisis.
“The Italian elections have prompted a fresh bout of uncertainty in European bond markets, with peripheral spreads widening sharply on the inconclusive result,” said Standard Life Investments’ investment director, Jack Kelly.
Standard Life Investments’ head of global strategy, Andrew Milligan, chimes in that investors need to think about ‘tail risks’. “At the very least, a prolonged period of uncertainty faces the Italian economy, affecting investor sentiment,” he said.
“In coming months, fiscal slippage and obstacles to structural and labour market reforms would not at all be well received by global investors,” he added.
“The probability is low, but not negligible, that Italy will have a referendum on EU membership before this political crisis comes to an end.”
AMP Capital chief economist and head of investment strategy Shane Oliver also emphasises the potential risks posed by a dramatic shift in Italian fiscal policy and general uncertainty.
“If the reform process does not continue, not only does it raise questions about Italy’s long-term growth potential thanks to an over-regulated and uncompetitive economy, it also raises questions as to whether it would be able to qualify for support from the European bailout fund and hence for support from the European Central Bank if a surge in its borrowing costs made that necessary,” he said.
“Hence, investors are fearful that stalled reforms and political uncertainty in Italy will lead to soaring Italian bond yields, the renewed risk of a break-up in the euro should Italy choose to leave, and a renewed threat to the global economy.”
But in a measured tone that Australian institutional investors may appreciate, Oliver has also called for calm, stressing that over-reaction to the Italian political situation would be most unwise.
“Uncertainty is likely to linger for several weeks, but as we have seen in recent times in Europe there is a danger of overreacting as blow ups have tended to settle down without the feared collapse of the euro,” he said.
“Our assessment is that while the correction in share markets may have a bit further to go, not helped by Italy, the broad rising trend in markets will likely continue.”
Following Oliver’s assessment, published on February 26, share markets did indeed have a volatile ride, getting hit hard initially as the results became known worldwide, as well as responding to the news of property tightening in China and the US Federal Reserve threatening to exit quantitive easing.
However, markets then rebounded to various degrees as worries subsided.
“Share markets mostly rose over the past week, with good US and European data offsetting Italy’s election results,” Oliver wrote on March 1, with US equities up 1.4 per cent, Japanese equities up 1.9 per cent, Australian shares up 1.4 per cent and Chinese shares up 2 per cent, while European shares fell 0.2 per cent.
“Shares have now entered a correction or consolidation phase which may still have a bit further to go in the short term, given risks around Italy,” he said.
But following the strong market rallies in January and the return of a bullish investment appetite, Oliver described this new period as the “correction we had to have” – a tongue in cheek reference to Paul Keating’s infamous assessment of the 1990s recession in Australia.
Speaking of the home front, the half-yearly profit reporting season wrapped up over the past month. “While overall profits were down, the outcome was far better than feared and there’s now some light at the end of the profit tunnel,” Oliver wrote in his February Australian overview.
Total profits are down around 10 per cent on December 2011, driven largely by a slump in resources profits, Oliver said. At the same time, 44 per cent of companies “exceeded expectations”, according to AMP; 53 per cent of companies have increased their dividends from a year ago and only 22 per cent have cut them; 40 per cent have exceeded expectations on dividends, with only 26 per cent delivering dividends worse than expected.
“The results were much better than feared, with upside surprises running at their highest in three years,” Oliver concluded.
“Moreover, the profit reporting season combined with signs that interest rate cuts are starting to get traction in driving stronger demand in the economy are consistent with the profit cycle having bottomed.”
The month in numbers
5,032.2 – The S&P/ASX 200 as of 14 March 2013, according to Proactive Investors
3.00 – The Reserve Bank of Australia’s official cash rate as of February 2013
-5 – The ‘business conditions index’, according to NAB as of 31 January 2013
3,635,000 – The number of Australians unemployed as of 31 January 2013, according to the Australian Bureau of Statistics
0.1% - The percentage increase in eurozone unemployment, according to AMP Capital
2,263.24 – The Shanghai Stock Exchange Composite Index, according to Proactive Investors
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