The Independent Market Observer

2/26/13 – Italian Comedians Win Election, Results Not Funny for Markets

Posted by Brad McMillan, CFA®, CFP®

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This entry was posted on Feb 26, 2013 9:06:14 AM

and tagged Politics and the Economy

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I was sitting on a plane home last night, watching SpongeBob with Jackson, and as I flipped through the channels, I saw that the stock market had cratered since we got on the plane. What?

A couple of days ago, I wrote that market risks were moving back into the forefront of investors’ thoughts, and that one of those risks was the pending Italian election. The results were actually worse than anyone had imagined, and, as a result, markets around the world sold off.

Three groups are essentially tied for votes in the Italian parliament: the center left, which Mario Monti, the former technocrat prime minister, is associated with; the center right, led by Silvio Berlusconi, the media tycoon and former prime minister also known for multiple indictments and “bunga bunga”; and the Five Star Movement led by Beppe Grillo, a comedian.

Italian politics has long been a train wreck—this is, after all, the country that gave us Niccolo Machiavelli and The Prince—so why should we care?

The reason this is important is that a majority of Italians have rejected, in no uncertain terms, the economic austerity program that stabilized the euro and the European financial markets. Monti took Italy from a financial basket case to stability, and thereby helped stabilize the eurozone as a whole—and he has just been rejected. Berlusconi has spoken out against the stability program, and the Five Star Movement has called for a referendum on whether to leave the euro completely.

Italy is the third-largest economy in the eurozone, and the fourth in Europe. A rejection by Italy of the austerity program led by Germany could prompt other countries, such as Spain—the next largest economy—to do the same. At that point, Germany would have to decide whether to allow the Italians and the Spanish to keep spending German money or to allow the eurozone to break up.

The situation is not so dire at the moment. Italy has entered a political Twilight Zone, which will last until the three parties determine whether some coalition can agree on a program to govern. If not, it will be back to the polls.

The big mystery here is exactly what the Five Star Movement representatives will want. Will they vote against everything? Will they ally themselves with one of the parties? Will they try to force another round of voting? We don’t know.

And that, in the end, is the problem. We thought we knew roughly how Europe would play out, and the Italian vote showed that we were wrong. Uncertainty has moved back to the front of the European project in a big way.

Markets hate uncertainty, and yesterday’s results reflect that. Today, we see a bounce back, as it becomes clear that we don’t have a problem yet, just the potential for one. Bear in mind, though, that even as markets go back up, the potential problem hasn’t gone away—and if that problem actually materializes, it will be a very big one.

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