Janus Point Of View: Arrivederci Renzi!

by: Janus Henderson Investors


Markets shrugged off the defeat of Italy’s referendum, a sign that investors are becoming more inured to political events.

With Prime Minister Renzi’s resignation, a quick transition of power is key to the stability of the country’s stock and bond markets.

European equities should prove resilient. The bigger tests will come in 2017, when both France and Germany go to the voting booths.

On Dec. 4, Italian voters rejected constitutional reforms that would have restructured the country's legislature and made it easier to pass new laws. The "no" vote is seen as yet another rebuke of traditional political establishments. Prime Minister Matteo Renzi, who had pledged to step down if the referendum failed, announced his resignation.

More uncertainty ahead

After the shocks of Brexit and the election of Donald J. Trump, Italy's referendum seemed to barely register on the market's radar. The euro, for example, sold off as results from Italy came in, but then rebounded within hours. As a result, we believe the market is becoming more resilient to exogenous political shocks.

Still, uncertainty remains. Italy's president, Sergio Mattarella, must now determine if Parliament can form a majority. If not, he will have to call for elections, which could bring to power the Five Star Movement, a populist group that favors abandoning the euro. Such an outcome could weigh on European equities (though it's important to note that the Senate is still highly fragmented, making it difficult for any single party to legislate).

Italian banks are also laden with non-performing loans and need to recapitalize. Given the political uncertainty, a private market solution won't likely be available to all banks, requiring the injection of public money. If Europe allows such an intervention without the full application of so-called bail-in rules (which would cause further turmoil among bank depositors and bondholders), Italian financial stocks could get a boost - but such a solution is far from guaranteed.

Indeed, a lot now depends on Italy's transition and the country's resolve to make much-needed changes. We believe the referendum's outcome could encourage the European Central Bank (ECB) to extend its easy-money policies for another six months, boosting equities in the region. If Mr. Mattarella cannot find a suitable replacement for Mr. Renzi, however, investors may shy away from risk. That could lead Italy's sovereign bonds, or BTPs, to sell off. Already, the 10-year BTP yields roughly 1.7 percentage points more than the equivalent German bund.

More broadly, the "no" vote signals that populism continues to gain momentum. Although Austrians rejected a far-right candidate for president on the same day as the Italian referendum, France goes to vote for a new president in April; Germans will decide whether to re-elect Chancellor Angela Merkel for a fourth term as soon as August. In both countries - the European Union's two largest economies - far-right parties have become increasingly popular among voters. The outcomes of those elections will have a momentous impact on the continent's markets. The fixed income and equity teams at Janus will be watching the results carefully.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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