No clear winner is expected to emerge from Sunday’s Italian election – meaning that no party or coalition will be able to achieve a majority – but this uncertain scenario will “calm the market and be good for the economy” in the short term, claims BCC Risparmio & Previdenza’s head of fund selection David Karni.
A hung parliament is preferable than a victory for the populist Five Star Movement led by Luigi di Maio which leads the polls but is widely seen as the worst-case scenario for equity markets, Italian bonds, and the single currency.
Karni said that if the centre right gained about 40% of the vote, as current polls predict, it could create volatility, although many investors remain more focused on the global outlook following widespread stock market sell-offs in January.
Franklin Templeton’s head of European fixed income, David Zahn, said an unexpected election result could provoke an outsized market reaction. He said it would most likely be the coalition of centre-right parties that could win most seats.
This coalition includes former Prime Minister Silvio Berlusconi’s Forza Italia party that has called for increased spending and a larger Italian budget.
“It currently looks unlikely to reach enough seats to win an absolute majority, but if it did creep over the line, that outcome could have negative repercussions on Italian debt,” Zahn said.
“The country’s central bank would likely be issuing more government bonds [BTPs] at a time when one of the biggest buyers, the European Central Bank [ECB], is scaling back its purchases of government debt.”
For NN Investment Partners senior economist for macro and strategy, Willem Verhagen, the main area of contention was the outlook for fiscal policy.
“Many parties want more room for fiscal easing, which may well bring them into conflict with the European Commission and the core eurozone countries. Nevertheless, we can imagine a compromise involving a trade-off between more fiscal flexibility and improved structural reform efforts,” Verhagen said.
Where to invest
Karni said there was more opportunity for investments in the Italian equity market but not from the fixed income side.
“Last week we cut our overweight to Italian BTPs, that we’ve had since 2011, and have gone back to neutrality. On the fixed income side, it is not the right time to buy as we have to wait for more interesting yields,” he said.
“The equity market is interesting because the PIR [tax-exempt individual savings plan] effect has not finished, and it was the great surprise of 2017, and this can push the market or sustain the market, and we believe Europe is in sweet spot to stay in the equity market.”
Last year, the Italian government introduced the PIR program to grow medium sized Italian companies. The funds (70% invested in Italian companies and 21% in small and mid cap Italian companies) created from this program allow investors to be tax exempt from capital gain if they stayed invested for five years.
Capital Group economist, Robert Lind, said while the Italian stock market had gained significantly over the past year, this could leave it vulnerable to any rise in eurozone or global interest rates, a slowdown in growth, or worries about the direction of economic policy under a new government.
Karni said he had put more weight on small cap Japanese funds and had bought more US equities as they were previously underweight and could profit from the downturn.
The rest of 2018
Karni noted that he expected volatility before the summer because he believed the central banks would make unexpected decisions.
“The ECB and the Fed are both on subtle equilibrium and both can change their ideas and speeches and so the market might react with just a little bit of noise. So, investors need to be more tactical this year,” he said.
“The run up to June could be really interesting and we could change some ideas to be more defensive because right now we’re very pro-risk and we’re overweight equities where we can.”