Like Jennifer Lawrence's fall at the Oscars, unexpected but a chance to shine 'comedically,' Italy's elections have shocked investors but provided attractive entry points to strong international firms, insulated from domestic woes (as well as offer up some funny one-liners from candidates). The possible loss of eagerly anticipated labour reforms, financial restrictions and market contagion provide shorter term sources of turmoil. However, existing reforms are likely to continue, market retrenchment is healthy and to be exploited for longer term opportunities.
3 Reasons to Be Worried
1. Political Risk: Loss Of Labour Reforms Crucial For Recovery
The biggest surprise of Italy's election was the clear rejection of Mario Monti, former premier and instigator of many of the reforms pushed through government over the last few months. This has highlighted how far anti-austerity sentiment has risen. The rise of the reform averse Berlusconi, further complicates matters as new labour reforms, greatly anticipated by investors, were hoped to allow the economy to recapture a degree of competitiveness and crucially kickstart growth. Even Bersani has announced he wishes to ease austerity. Without Monti, and with a possible coalition with Berlusconi instead, new reforms look less likely.
2. Financial Risk: Inability To Request Support To Tackle An Elevated Cost Of Borrowing
Without a government to sign a Memorandum of Understanding, Italy is unable to request aid under OMT (the Outright Monetary Transaction). This means the European Central Bank cannot buy their sovereign bonds in an attempt to bring down bond yields which have risen on the back of this political uncertainty. Even aside from this, the ECB is at risk of removing support at any time, if they feel Italy is moving in the wrong direction. Again, highlighting the importance of reform, the ECB stopped buying Italian bonds in August 2011 when Italy was seen to renege on certain measures. However, this ultimately led to the resignation of Berlusconi as borrowing costs and the outlook for Italy became tenuous and therefore he may be more encouraged to keep to current reforms this time around.
3. Market Risk: Contagion
Driving markets globally, turmoil in Europe revived concerns over the sustainability of the region and survival of the euro. Outside of Italy, Spanish sovereign bond yields rose and the US stock market suffered their biggest single day decline in nearly four months. Unable to remain an isolated incident, political uncertainty has far reaching consequences.
But Three Reasons This Is a Buying Opportunity
1. Status Quo Will Be Maintained
Although investor hopes for new labour reforms seems less certain, the continuation of reforms already in place is more likely. As mentioned before, Italian leaders have been victim to the withdrawal of support from the ECB previously and with measures already having progressed through government, their effect on the wider economy could still be palatable.
2. Shakeout Healthy
The markets saw huge swings during the election process, and short term traders cutting risk. Markets have been rattled from the combined effect of election disappointment, U.S. spending cut negotiations, UK debt downgrade after a strong rally over the past few months. Retrenchment is healthy. This leaves room for longer term investors, desperate to put cash back to work, an entry point into markets and a more stable source of support going forward.
3. Profit-Taking to Be Exploited
Finally, although this is a chance to be opportunistic, the focus is on buying companies with strong long-term outlooks. International firms may be overpunished by the turmoil in the region where they are headquartered or the stock market on which they are listed, but generate a majority of revenues overseas, insulating them from pressure domestically. Furthermore, once a government is established, the possibility of assistance from the ECB provides a level of support. Companies are cash rich and can offer attractive opportunities over the longer term with any strengthening of global growth.
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