October 24, 2016–Given the market volatility that followed the unexpected “leave” outcome in the U.K.’s Brexit referendum, it is understandable that global investors would be concerned about any European referendum. Hence, a great deal of global investor attention has turned to an Italian referendum scheduled for December 4.

The question on the ballot is whether to strip legislative powers from Italy’s regionally elected Senate.     Currently, the Chamber of Deputies (the equivalent of the U.S. House of Representatives) and the Senate are co-equal chambers of parliament, much as is the case with the U.S. Congress.  A “yes” vote in the referendum would reduce the Senate to a smaller, consultative body. Current opinion polling suggests a slight preference for a “no” vote, however, many voters remain undecided.

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Source: Sondaggi Politico Elettorali – Italian Government; WTIA

The referendum would make it less burdensome for Italian prime ministers to obtain parliamentary approval for proposed legislation.  The current prime minister, Matteo Renzi, sought the referendum so he could more easily secure passage of economic reform measures that had encountered obstacles in the Senate. The referendum has support from Renzi’s Democratic Party, and other parties in his centrist coalition, but is opposed by the Five Star Movement (5SM).  Renzi has indicated that he would resign as prime minister if the referendum were to fail.

Many Italians agree with the proposition that the Senate unnecessarily hampers legislation already approved by the Chamber of Deputies. They are likely to vote “yes,” although many value the Senate as a guardian of the interests of Italy’s regions. Further, since the prime minister’s coalition by definition controls the Chamber of Deputies, some Italians who are likely to vote “no” view the Senate as a check against potential governmental abuse of power by would-be authoritarians, such as a Silvio Berlusconi.

By contrast, global investors tend to view the referendum as a competition between two contrasting political visions of Italy’s economic future. For them, a “yes” vote would imply endorsement of the Renzi government’s generally market-friendly economic policies, while a “no” vote would imply endorsement of 5SM’s populist, eclectic, and occasionally “Eurosceptic” (anti-EU) message.

Some global investors may be worried that a “no” vote would trigger a political crisis that could ultimately lead to 5SM rule. We believe such a possibility is highly unlikely:

  • Were Renzi to resign, his governing Democratic Party would quickly elect his replacement
  • The constitution does not require a general election before May 2018, so there is no immediate electoral opportunity for 5SM to exploit momentum from a “no” vote
  •  In the meantime, the Democratic Party and its coalition partners will continue to enjoy large majorities of seats in the Chamber of Deputies and the Senate

Some global Investors might also be worried that a “no” vote would increase the chances of Italy exiting the EU or the eurozone. We believe it is highly unlikely that Italy will follow the U.K.’s lead:

  • All parties in the governing coalition are fully committed to EU membership  
  • If the Eurosceptic 5SM were to come to power in 2018, its leadership would likely give priority to implementing its core policy agenda, which does not include an EU exit 
  • A U.K.-style popular referendum on an EU exit is not legally possible, since the Italian constitution precludes referenda on international treaties
  • Many Italians are witnessing British anxiety in the face of impending Brexit and may wish to avoid such an unpleasant experience   

While Italy is one of Europe’s largest economies, one should be careful not to overstate its importance to global financial markets. The market capitalization of Italy’s stock market is only 3% of Europe’s, roughly the same as that of Sweden or Denmark. By contrast, the market capitalization of the U.K.’s stock market is 29% of Europe’s. Further, Milan is a relatively minor financial center, compared to London, Frankfurt, Paris, or Luxembourg. Italy’s recent financial market significance has stemmed mainly from the challenges faced by several of its banks, namely Monte dei Paschi di Siena.

A “no” vote in the referendum may represent a lost opportunity for Italy to finally achieve an upward inflection in long-term economic growth. However, we expect a “no” vote would likely cause no more than a slight, temporary disruption to European and global financial markets.

Core narrative:

Our benign view on the Italian referendum is consistent with our near-neutral tactical allocation weight to developed international equities.

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