Italian results offer few reasons for market optimism

CAPITAL COMMENT

LAST week, my column considered what the Italian elections might mean for the financial markets. I noted that there was a broad feeling that we were only witnessing the quiet before the storm. And by the way the markets have reacted since, it’s clear that few were prepared for the actual outcome. We now find ourselves in a situation reminiscent of some of the worst periods of the ongoing Eurozone debt crisis to date.

More than anything, the results show just how marginalised Italian voters have become, and there are streaks of extremism creeping into the electorate’s mindset. We also saw this in Greece, where a significant share of the votes in the June 2012 election went to parties of the far-right and far-left.

But the main messages to come from Italy are anti-austerity and worryingly eurosceptic. This is largely a concern because the country has been mired in recession for quite some time, and still has a substantial debt burden. Reform so far has barely touched the sides.

The road ahead doesn’t look bumpy, it is riddled with pot holes. Goodness knows whether any further badly-needed reforms will be implemented. It could take weeks to form a coalition, which looks improbable at this moment in time. And even if one were ever to materialise, it’s improbable that such a coalition would be effective or stable enough to deliver the agenda needed to get Italy’s economy back on track. Fresh elections in a few months time are a distinct possibility, but investors must first try and avoid all those pot holes before we get there.

The markets have spoken and shown why this election means so much. Italy has over $3 trillion (£1.98 trillion) of debt, the third largest mountain in the world after the US and Japan. This year alone, the country has to roll over $300bn worth of it. Italy’s borrowing costs spiked yesterday, and equity markets and the euro plunged – although perhaps not by quite as much as some might have expected. There was also some resemblance of a bounce later on in the session. Despite the overall uptrend looking like it remains intact from a technical point of view, the fear was nevertheless palpable, as red flashed across our screens for most the day.

Interestingly, throughout Tuesday’s session, there were a lot of people claiming that this was a tremendous opportunity to buy stocks on the weakness. Many cited the fact that the European Central Bank (ECB) will always be on hand to fill in the pot holes. But even the ECB might run out of patience if Italy fails to reform and kicks the can even further down the road. And when so many people start screaming “buy”, it makes me slightly nervous. It could just be worth sitting on the sidelines for the time being. You never know – things could get a little cheaper in the days or weeks ahead.

Angus Campbell is Head of Market Analysis at Capital Spreads. You can follow him on Twitter @AngusCapSpreads

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