Over the past two months Italian politics showed once more it can have more twists and turns than the mountains of the Giro.
First, elections in March proved inconclusive. None of the parties or traditional coalitions emerged with enough votes to control the parliament. Then the anti-establishment Five Star Movement and the far-right Northern League parties, who were worlds apart during the campaigning phase, joined forces in an attempt to form a government.
Their ambitions were quickly neutered by president Sergio Mattarella. Mattarella rejected the nomination of the 81-year old Eurosceptic Paolo Savona as the minister of economy, putting an end to the odd alliance. Italians are now headed for another round of elections, expected to be held in August.
Financial markets are clearly worried. The spread between Italian long-dated government bonds and German Bunds – the latter considered the least risky in Europe – blew out to more than two percentage points. That’s the highest level since the Greek-led Euro crisis of 2011. And the Italian bourse fell 20% over a few trading sessions. Is this an opportunity for investors or the start of a prolonged crisis?
Political instability in Italy is nothing new
The reaction is understandable. The two populist parties will claim that Mattarella unfairly stripped them of power and may well get more votes in the next election.
Italy’s public debt currently stands at about €40,000 per person. The populist parties’ aversion to spending cuts suggests that, under their leadership, it will likely continue to grow. Also their scepticism towards the European Union could lead to a return of the Lira, the pre-Euro local currency. This would leave bondholders and equity investors exposed to currency devaluation losses.
But the reality is that the weakness of the Italian political system is nothing new. Since the early '90s in Italy there have been many parties that appeal to diverse groups. Citizens can only vote for one. The result is that it is extremely rare for one party to win enough votes to have a clear majority. So the stability of the Italian government has often relied on fragile alliances that tend to break at the first sign of disagreement. This is why new reforms have been so hard to implement.
Unless the Italian political system changes, even if a populist government is elected in August, the likelihood that it will be able to enact the most extreme reforms – such as going back to the Lira – remains low.
Italian banks have been the main drivers of the recent stock market tumble due to their holdings of Italian bonds. However, over the past couple of days falls have extended to stocks that have little exposure to Italy and in some cases to the Eurozone. A few months ago my colleague Gareth Brown lamented the fact that the Italian market, once a good source of cheap stocks for the International Fund, had become expensive. Some heavy falls are welcome.
If you are interested in receiving the Forager monthly and quarterly reports, please register here.