At the beginning of the year, a clear lead for Pier Luigi Bersani’s centre-left coalition indicated that we were headed for a somewhat predictable, uneventful outcome to the Italian general election on 24 February.
Fast forward two and a half months and how things have changed.
Major gains by parties on the right, including Silvio Berlusconi’s People of Liberty (PDL) party, have thrown open the election race, just weeks before Italians head to the polls.
Particularly damaging for the centre-left has been its close association with Monti dei Paschi bank, tarnished by the scandal of irregular derivatives trading that pushed Italy’s third largest bank to the brink of collapse.
This kind of risk association, at a time when Italians are looking for strong, stable leadership, has cost the centre-left coalition considerable support.
What this means for markets
Unsurprisingly, the gains made by the right over recent months have heightened Italian political uncertainty – a fact directly reflected on financial markets, with benchmark 10-year yields spiking roughly 50 basis points over the past two weeks (source: Trading Economics/Italian Treasury Department).
However, while this worry is understandable, our take on recent developments is somewhat contrary to the generally negative consensus opinion.
The advances made by parties on the right have undermined what looked like a clear-cut outcome for the centre-left coalition. The prospect of a commanding centre-left majority government now looks far less certain and this uncertainty has clearly impacted sentiment.
However, in our view, far from being a negative, the convergence of support between right and left is a positive development, given it has thrust former PM Mario Monti and his Civic Choice party into the spotlight.
The role of Monti
Mr Monti’s appeal as a likely ‘referee’ between right and left, heightens the prospect of a centre-left/Monti coalition government being formed – something we see as very positive.
Indeed, Mr Bersani has stated that he will continue the reformist policies begun by Mr Monti, building on the progress made over the past year.
A stable coalition of this kind, with Mr Monti as a key figure, remains our main case scenario. As such, we expect to see a fall in the risk premium associated with Italy, prompting bond yields to decline and equity markets to rally.
The banking sector would be one of the major beneficiaries of any decrease in yields, reversing the spike in financial risk premium evident in 2012.
A key risk to this scenario is that the 5-Star Movement, a populist, anti-establishment organisation, secures a high number of votes.
However, given the disparate, often extreme, collection of views represented within 5-Star, we expect a limited election outcome, therefore little risk.
If this scenario did come about, with 5-Star a prominent influence, it would undermine the current reform programme, raising questions, not only about Italy’s stability, but also the stability of the Euro area in general.
However, this is not our main view.
We expect that Italians will respond positively to the need for political stability and ongoing structural reform and will be mature enough to make the correct choice come 24 February.
The AXA WF Framlington Italy fund returned 14.57% in the three years to the end of January 2013. This compares to its Citywire benchmark, the MSCI Italy TR, which fell 7.64% over this period.