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What Italian Populism Means for U.S. Equities

2 | By Shah Gilani

Political drama in Italy is rising to a fever pitch, with most voters in March’s parliamentary elections handing victory to two populist parties.

The coalition government of the far-right Northern League and the anti-establishment Five Star Movement put forward a prime minister candidate for the president’s approval this weekend.

That didn’t happen.

Now, these events in Italy are threatening to boil over – and U.S. equity markets could be affected as a result.

Here’s what’s really at stake for Italy and Europe, and how it could send U.S. stocks back on their upward trajectory…

Another Year, Another Government

As far as politics go for Italy, you could say, “another year, another government.” That’s because in the 73 years since World War II, Italy’s had 65 different governmental systems.

This time around, voters gave two competing parties, the Northern League, which garnered 18% of the popular vote, and the Five Star Movement, which won 32% and is Italy’s biggest party now, a chance to join forces – and to push their essentially populist positions.

They formed a coalition, and, after a lot of “sausage-making,” put forward their candidate for prime minister, whom the President of Italy, Sergio Mattarella, Italy’s twelfth president since 2015, must approve.

The problem with Giuseppe Conte, the coalition’s neophyte and little-known academic prime minister candidate isn’t necessarily his politics. It’s who he and the coalition wanted his chief economic minister to be: Paolo Savona.

That’s former Bank of Italy official, 81-year old Paolo Savona. Mr. Savona is a well-known Eurosceptic. One of the more inflammatory things he’s said about Germany’s outsized influence on the European Union and the Monetary Union’s euro-centric economy is, “Germany has not changed the vision of its role in Europe after the end of the Nazi era, although it has abandoned the idea to impose it militarily.”

Mr. Savona wrote that Italy should prepare for the eventuality of leaving the euro “… Whether we are forced, willingly or unwillingly, to do so,” a position anathema to Italy’s pro-European president.

With the president’s rejection of Giuseppe Conte over the weekend and the president putting forward International Monetary Fund official Carlo Coltarelli as his choice to form a new coalition government, all hell broke loose – again.

“We were ready to govern, and we were told ‘No,'” said Five Star Movement leader Luigi Di Maio Sunday evening. “This is unacceptable. This is an institutional clash unseen before.”

Mr. Di Maio now wants parliament to impeach President Mattarella for allegedly “betraying the state.”

On Sunday, Matteo Salvini, the 45-year-old leader of the Northern League, suggested Italians should now go back to vote.

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What’s frightening to pro-E.U. Europeans is the new coalition government promises to rewrite the rules for the single currency, wants to deport hundreds of thousands of immigrants, cut oppressive taxes, and establish a universal basic income for Italy’s poor and unemployed.

Those are just the broad strokes of what’s being promised. The finer details are far more alarming.

Italy’s already got over $2.3 trillion in public debt and is only able to borrow to pay interest on its debt because being in the European Monetary Union, which many in the new government say is the reason they’re doing so poorly economically.

Italy’s the only country in the E.U. that hasn’t seen its GDP rise above pre-2008 levels.

But as things worsen for Italy and the European Monetary Union throughout this ongoing political drama, things will be coming up roses for U.S. equities, following initial sympathy selloff.

Why?

Because the euro’s already taking a hit. It’s down 4.8% against the U.S. dollar, just since April 16 of this year.

The Euro’s in Trouble

While political uncertainty spreads across Italy, the rest of the European Union looks to be slowing down economically.

Business activity, based on an IHS Markit producers manufacturing index of 5,000 businesses, looks to be slowing. The index which came in at 54.1 in April, was down from 55.1 in March, and is now the lowest it’s been in 18 months.

If Euro Zone economies continue to diverge from the on-going steady growth in the U.S., and the Federal Reserve raises rates here while the European Central Bank (ECB) keeps rates in negative territory across most of Europe, more money will flow into the dollar and into U.S. assets.

That means the euro will keep falling, proving economic weakness and need for the ECB to continue their “quantitative easing,” which means buying E.U. nations’ government debt and Euro Zone corporate debt.

All that maneuvering will eventually see the dollar strengthen even more against a falling euro, and drive more investors out of the euro and into dollars.

And, of course, if U.S. equity markets consolidate after an initial “risk-off” sympathy selloff, which they will do because earnings here are stellar and companies are cash rich, domestic markets will work their way back to higher highs.

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On Friday, I’ll tell you what else could go wrong in Italy and Europe, and with emerging markets, that will further drive international capital into U.S. dollars and assets.

Get ready for the next leg up in the market, it’s coming after an initial round of risk-off selling.

However…

I realize that this is a lot to “hope” for in the markets. It’s always some equation, some convoluted formula that requires exactly this or exactly that to happen for a chance at something positive.

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Sincerely,

Shah

2 Responses to What Italian Populism Means for U.S. Equities

  1. JC Sandberg says:

    I really liked the vix & vvix article. I really wanted to read it over again, but it seemed to disappear on me. It sort of felt like I might actually be on the verge of learning something important. Thank you very much (& would love to see it again; maybe in the archives?) My whole family likes to treat me like poop, just because I fell for a nightmere; but, the vix article made me feel like, “Who cares? ” Maybe I learn some of this, be happier, and maybe that’s enough. Big thanks.

  2. brian naylor says:

    The “elefante” in the Italian room is the core belief of The Northern League: that there is no REAL “Italy”—that it is just an artificial political construct not even 150 years old—and that the northern provinces (essentially, Cisalpine Gaul, from Julius Caesar’s time!) would do MUCH better as their own, SEPARATE COUNTRY! Of course, that cannot be accomplished in one quick step; I think that they plan to do it in stages: first, lessen, then eliminate, Italy’s participation in Merkel’s Vierte Reich; then expel Sicily and Sardinia from the remaining Italian nation-state; and finally, withdraw the northern provinces from Italy all together, leaving the remaining “Italy” a physically isolated, backward, economic basket-case, as the entire industrial, financial and cultural base lives up NORTH—even the Roma of “la Dolce Vita” days has been replaced by the fashion houses of Milan. The “mille lire” question is: for how long will das Groessten Deutschland tolerate that? Not long, me thinks! “What strange beast now slouches towards [Brussels] to be born again?” (With apologies to W.B. Yeats).

    Now, I’m not saying that any of this would be a good idea, or that it would make any sense AT ALL…but hey, we’re dealing with politics here—and ITALIAN POLITICS to boot (no pun intended). “There’s a pleasure sure, in being mad, that none but madmen know!”

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