Investment Insights: Déjà vu and the Italian ‘Brexit’

Wade Balliet
Posted by Wade Balliet
Investment Strategy

This weekly report presents insights from our Global Investment Management team.

Italian flag flying in historic sculpture-filled plaza.Investors may be getting a familiar feeling as turmoil in Europe spills into global financial markets. Stocks fell around the world after political discord in Italy that may lead to snap elections – a vote that could represent whether Italy remains within the currency bloc.

The S&P 500 declined 1.15% yesterday as U.S. markets opened after the long weekend, while stock gauges in Italy and Spain lost approximately 2.50%, according to the FTSE MIB and the IBEX 35, respectively. Domestic bonds performed well amid the heightened risk-off sentiment, but European bond yields rocketed higher on the news. The situation appears to vaguely resemble a combination of Britain’s vote to leave the European Union in mid-2016 and the supposed peak in the European debt crisis during 2011-2012. However, there are key differences between the two, and the implications of Italy’s vote may be even more meaningful to the Eurozone.

It is important to remember that the European debt crisis is still an ongoing issue, but it came to a head years ago due to concerns surrounding Greece’s financial debt and potential exit from the Eurozone. The crisis started amid the fallout of the Great Recession after the collapse of banking systems and high government debt. Fears of a “financial contagion” that would spread to the rest of Europe topped headlines. Concerns over the debt crisis were laid to rest in mid-2012 following an austerity election in Greece, bailout agreements, the establishment of the European Stability Mechanism, and the European Central Bank’s announcement to do “whatever it takes” to preserve the euro.

While some of the same remedies that worked for Greece may do the same for Italy, it is an exceptionally complicated economic and financial situation. Problems with Italy will make for a much larger threat to the stability of the European Union compared to Greece. According to Eurostat, Greece accounted for just over 1% of the EU’s 2017 total GDP, while Italy – the third largest economy in the region – accounted for over 11%. Additionally, Britain is in the years-long process of exiting the union as a political-economic member since it never adopted the euro, but the process for Italy would likely be much more painful and difficult. For citizens of these member states, it seems to boil down to whether they feel better off as part of the union – a structure including a common currency, but without a fiscal framework – or if they believe they are better off without it.

The Global Investment Management team continues to watch for developments. As we have mentioned numerous times, volatility has made a prominent return to financial markets; and much of it has been based on geopolitical events. If Italy does cast a disapproving vote against the EU, it will create a substantial challenge for the zone – and to a greater degree than Brexit. The situation in Europe, a potential slowing in economic growth domestically, and the Fed’s path for rates remain our key points to monitor.

Chart showing various market returns as of 5/29/18

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