Italy’s election results and its hangover have suddenly brought uncertainty back into the markets in most places.
It’s a fact that most of the investor community got overly complacent as they fully priced in (expected) political stability (continuity) in Italy and did not take into account implied risks of an election in the country and surely didn’t pay attention to what history has taught us: you never can trust Italian polls.
Italy, which is the third-largest economy of the eurozone and the European Union and ranks eighth in the world, got the worst-case election outcome for investors. The feared election results in the upper house of the Italian Parliament (Senate), which has practically equal policymaking power as does the lower house (the Chamber of Deputies), where none of the three political blocks has been able to secure a majority, now faces a political paralysis for the foreseeable future. This could, eventually, result in new elections within only a few months.
In the meantime, the Secretary-General of Silvio Berlusconi’s party has already suggested that the votes be recounted, given the narrow gap between the two biggest blocs in the Senate.
Unfortunately, and I don’t think it’s an overstatement to say, a “fat tail risk” has suddenly reappeared in the eurozone after the Italian electorate has clearly rejected austerity and further European integration, as well as what’s called “internal devaluation” that has been imposed by the Brussels’ elite and has been executed by the non-elected technocrat Mario Monti.
The big question that arises now on is: will there be an Italian contagion? I’m convinced that policymakers in Brussels will do all that it takes to prevent just that. As usual, we’ll have to be patient for seeing with what kind of “bandage” they are going to come up with.
As far as things stand today, I expect future Italian policy decisions on further essentially needed reforms (e.g., labor reforms) if once voted in the lower house where the center-left has a comfortable majority, could be bound, falling prey to the horse trading of the upper house.
Investors should watch out for when new elections would become necessary again.
If that wasn’t sufficient alone, there is also an interesting, but at the same time critical, detail.
In case Italy would become “un-governable” in the near future, which I think is a great possibility, only the President of the Republic can call an election. Now, the current seven-year presidential term of Giorgio Napolitano is ending on May 10, and therefore Napolitano would probably not be able to dissolve parliament and call an election.
To make things even more complicated, it would be this newly elected parliament that would be called to elect in May a new president, and it would need to do so with a two-third majority. Keep in mind, the official talks over who will form the next government will not start until March 15, when the Italian parliament reconvenes.
No, that doesn’t look good.
That said, the only thing that’s for sure today is that plenty of uncertainties are heading irrevocably our way. These uncertainties have the potential of troubling, at the least, the process of further building of credibility of the European Monetary Union, which is, unfortunately, not part of an absolutely necessary political and fiscal union as the European Union fails on both issues so far.
Long-term investors should also keep a close eye on France, which is struggling to meet its deficit target and will probably be obliged to extend its already-hurting “living with less” situation. Many voices of discontent continue to rise in France, but also in Spain, Portugal, etc.
At the same time, in the United States, the fiscal debate remains stuck in the mud. If they will be able to muddle through remains an open question.
So far, it looks like on Friday, the sequestration will kick in. In the meantime, Acting Treasury Secretary Neal Wolin said, “Shocks are bound to come. But what we cannot do, what would be a grave and unnecessary mistake, is to deliberately throw sand in the gears of our recovery.”
What will happen on Friday is anybody’s guess.
The question that arises here is if we’ll see the next “Grey Swan” erupting in the United States if the irrational sequestration kicks in after the Italian “Grey Swan” has already surprised most of the investor community.
I would remain sitting on my highly liquid cash equivalents, by preference in U.S. dollars, that have their homeport inside the United States. How long that could go on, I can’t tell, as uncertainties seem to be coming back with a vengeance.
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