On Sunday, March 4th, Italians delivered a stunning populist defeat to traditional parties of both the center-left and the center-right. As we pointed out in our (see "A surprise, Italian style" ), the anti-establishment Five-Star Movement and the far-right Lega outperformed unadjusted polling averages by a remarkable 9%. In our preview of Italy's parliamentary elections, we had highlighted the plausibility of just such a scenario given how unusually unreliable Italian polling has been in the past. (see "An Italian muddle" )
What even we found a touch surprising, however, was the quick restoration of calm in financial markets, following the electoral upset. On a one-month basis, Italian equities have performed pretty much in line with their European peers. Meanwhile, spreads of Italian sovereigns over German Bunds already started to tighten again on Thursday. Even in Italy, it appears that the European Central Bank's (ECB's) policy makers' meeting and uncertainty over U.S. trade policies have been bigger drivers over the past week than domestic politics.
This is consistent with our probability-adjusted views heading into the Italian elections and our positioning since. Italian economic growth appears reasonably strong and corporate earnings growth solid. In itself, we believe the prospect of endless haggling over what sort of coalition might eventually emerge is no reason to sour on Italy. Both the Lega and Five-Star have tuned down their rhetoric on Italy's Eurozone membership. It remains to be seen how much either one of them might increase government borrowing.
And there is one additional reason that gives us comfort, highlighted in our Chart of the Week. Over the past 30 years, Italian households have steadily been reducing their exposure to Italian government bonds. Thanks to the ECB's asset-purchasing programs, 18% is held by central banks, foreign investors hold 35% and 41% is with Italian financial institutions, as of November 2017. Non-financial domestic investors, such as Italian households, owned a mere 5%. Given this split, political troubles in Italy could still prove destabilizing, but more so for the rest of Europe than for Italy itself. To paraphrase that age-old piece of wisdom: "If you have 100,000 euros of debt you find difficult to service, you got a problem. But if you have 2.2 trillion of debt, your problem is everybody else's." Incidentally, this is also one of the reasons why we continue to see a decent chance for some of the necessary reforms to the Eurozone's functioning to emerge – eventually. Not that Italian voters have made this any easier.
Sources: Bloomberg Finance L.P., Deutsche Asset Management Investment GmbH, as of 3/8/18