Italian referendum and global markets: What’s next in 2017


‘Once more unto the breach’. We imagine financial markets feel similar to the troops in Shakespeare’s King Henry the Fifth, after the 'no' vote in the Italian referendum on constitutional reform.


Political events and the markets: The dangers of overreacting

In a year full of political upsets, markets have to once more overcome uncertainty. With a 59.1% to 40.9% margin (Source: Bloomberg; 8.00am GMT) against the proposed constitutional and political reforms, Italy’s Prime Minister Renzi suffered a defeat that cost him his job as he tendered his resignation this morning. However, beyond short-term volatility, we don’t see this potential setback for the Renzi government as a game changer for our market outlook and upcoming 2017 Global Market Outlook – Annual Report, to be released on Dec. 6. Please click here to view the document.

The outcome of the referendum is clearly a concern for the European Union (EU), both politically and in terms of its impact on financial markets. On the political front, after Renzi’s resignation the question is whether Italy’s President Sergio Mattarella will call for new elections or opt for a caretaker government. I continue to believe it is unlikely that new elections will be held.

The president is keenly aware new elections would probably not resolve anything and would create a lot of unwanted uncertainty. I believe a continuation of the current government, potentially led by the current Minister of Finance, Pier Carlo Padoan, is the most likely outcome.

Under those circumstances, we expect markets to take this event in its stride. After all, nothing much has changed and, in the absence of a political crisis, we believe it will quickly be business as usual. Indeed, the market reaction so far confirms a sanguine attitude with equities even slightly up and the euro only slightly down.

The concern that this 'no' vote will push Italian government bonds and bank shares into a self-reinforcing downward spiral is not likely to materialise. The European Central Bank’s backstop through its quantitative easing program is too powerful. And a bank recapitalisation effort will likely gain momentum should stress levels rise.

That being said, the outcome of the referendum is a potential setback for the EU, as it strengthens the country’s populist-oriented political parties, which question Italy’s inclusion in the European Monetary Union and/or use of the euro as its currency.

Still, we believe it is important to not overreact to political events. Two political examples of investors having an abrupt over-reaction to political headlines where the markets soon course-corrected are quite recent. For example, we saw that while markets reacted swiftly and negatively to the Brexit vote, they soon recovered. And later, while many expected equity markets to react negatively to the 2016 U.S. presidential election’s outcome, equity markets actually experienced a Trump bump as the S&P® 500 Index ended up 3.4% for the month of November.

So, where does that leave us, as we look toward 2017?

As we noted in our 2017 Global Market Outlook (being released Dec. 6), we anticipate a challenging investment environment in the new year.

Near-term, we expect global economic growth is likely to improve, spurred by fiscal stimulus as political leaders worldwide move away from austerity. Longer-term, however, our global team of investment strategists think the prospect of trade protectionism raised by Brexit and the U.S. presidential election could mean slower growth and higher inflation.

We’ll watch closely for evidence that markets have moved too far into fear or euphoria and look for downside protection when it is cheap.

In our 2017 Global Market Outlook report, titled, “The New Abnormal,” we explain why we believe the search for yield is not going to get any easier in 2017 against a backdrop of record U.S. equity prices, narrow credit spreads and low bond yields.

As our Global Chief Investment Officer Jeff Hussey says: "Investors will need to venture further afield in search of returns, using the full range of tools available in a globally diversified, multi-asset portfolio.”

To learn more about our investment strategists’ perspective for 2017, click here from 6th December.