In the end, it was not even close. Some 59% of voters rejected a wide-ranging package of constitutional reforms. If approved, the new arrangements would have centralized more powers in Rome and shrunk the upper chamber of Italy’s parliament while limiting the Senate’s powers.
As the scale of the defeat became clear, Italian Prime Minister Matteo Renzi promptly resigned.
There are three lessons investors should draw.
First, polling has been much maligned this year, in the aftermath of the Brexit vote and Donald Trump’s victory. These reactions were misguided. It would be equally misguided to praise Italian pollsters for their clairvoyance. Italian polls consistently showed “No” ahead, but with some 20 – 25% of voters undecided. Based on this data the “No” blow-out we actually saw was about as plausible as a narrow “Yes” win. Ahead of next year’s heavy electoral calendar, this should serve as a useful reminder not to read too much into polling results, but not to dismiss them either. Polls need to be interpreted with care and can rarely give you certainty.
Second, political change rarely happens overnight. Initial hopes of Renzi swiftly curing the Italian disease were overdone, but so would be despair following his departure from the Palazzo Chigi, the official residence of Italy’s Prime Minister. For now, we consider a snap election very unlikely, at least until the constitutional court weighs in on the new election law early next year. This would ensure that the winning party gets at least 54% of the seats in the lower house of Italy’s parliament. An incoming transition government might well amend this, to make it more favourable to coalition government.
Third, it is not “all about politics.” Already, the market focus is shifting back to the ailing Italian banking sector and the upcoming announcement by the European Central Bank on Thursday and the potential prolongation of quantitative easing (which remains our base case). Monte dei Paschi di Siena continues its scramble to raise capital from private investors, but chances of a quick fix continue to look remote.
With all that in mind, we are not surprised by the fairly measured market reactions to the political turmoil so far. On currencies, much of the initial euro weakness has already reversed. On Italian sovereigns, we may not have seen the worst yet, but this could potentially offer attractive entry points. Corporate bonds are likely to remain well-supported by monetary policy. As for equities, keep in mind that the market capitalisation of the Italian equity market as a whole is less than half of that of Apple Inc. alone. That said, we remain strongly underweight in Italian banks.
In the longer term, we would argue that the failure to pass Senate reform has made big changes to the status quo less likely - in either direction. On the one hand, it means market-friendly, structural reforms remain as hard as they have been for decades. Renzi and his reform agenda have clearly suffered a setback. On the other hand, any Five Star led government would find legislating as difficult as its predecessors. This would make it harder to push a Eurosceptic agenda, were Five Star to win the next election.