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The Italian Job
by Steve Visscher, Mawer Investment Blog
“The European Central Bank is ready to do whatever it takes to preserve the Euro. And believe me, it will be enough.”
– ECB President Mario Draghi
This bold message delivered last August was exactly what worried investors had been craving. If the ECB was prepared to unleash its full financial might to address the crisis, then we could start worrying about something new. Before long, Greece had faded from the daily headlines. The PIIGS acronym disappeared from our lexicon. European sovereign yields fell. Stock markets rallied. Draghi’s decisive statement seemed to work.
Until this week’s Italian election.
European debt fears returned to the headlines. European bond yields rose, and equity markets declined around the world, at least momentarily. Though equity markets have since recovered these losses, many were left pondering why markets reacted so negatively to an inconclusive Italian election. Does it really matter if the ECB is prepared to intervene with full force?
We can only speculate, but investors may be worried about the conditions attached to the ECB’s bold promise. The intention was that the ECB would intervene, provided that countries were making progress on financial and economic reform; reforms that may be painful in the short-term, but which we believe are necessary for Europe’s long-term health.
Italy had been making progress on reform, but the political parties driving these changes did not fare well in the election. Meanwhile, voters rallied behind parties that opposed ECB recommendations. Not only did this raise concern over whether Italy can maintain its reformist path, it now puts politicians throughout Europe on notice. If you want to get elected, your chances may be greater if you adopt an anti-austerity, anti-ECB platform.
It’s too early to say how this drama will play out. If and when Italy forms a ruling government, will they undo the reforms to date? Will this prompt the ECB to withhold support that was so boldly promised last August? The stakes are high given that Italy’s economy and amount of outstanding debt dwarfs that of Greece.
Though many equity markets have recovered since the election sell-off early in the week, bond markets appear more concerned. We have likely not heard the last from Italy. Although we don’t hold any Italian companies directly and believe our portfolios are resilient to a wide array of outcomes, we’ll be monitoring this story closely as new opportunities and risks present themselves.
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