Italian Referendum: Globally Diversified And Stock-Selective Investors Required

Ahead of the important constitutional referendum taking place in Italy this Sunday, Raj Shant, global equities manager at Newton Investment Management, part of BNY Mellon Investment Management (IM), shares his views.

The outcome of the Italian referendum is pretty binary. If it’s a 'yes' vote the tide of populism throughout Europe would recede as a threat. If the referendum is lost, then we may quickly get a technocratic government – but elections would have to be called soon with the anti-Euro, anti-establishment 5-star Movement party likely to gain a key role in any future government. Given what is happening in global bond markets, the unsustainability of Italian sovereign debt would be twinned with the ungovernability of Italy. There is a high risk that banking recaps would fail. If there was contagion from the banks to the government and from there to the euro, given Germany’s own political calendar it is hard to imagine that the Germans can allow the ECB to step in to intervene on an even bigger scale than it is doing at present.

Overall, a 'no' vote might lead to an immediate move towards 'risk off' move by global investors, but even a ‘yes’ vote doesn’t resolve the mountain of unprovided bad loans on the balance sheets of many Italian banks and the fact that the constitutional reforms bestow much more power on future governments –which may create even more problems if the 5-star Movement wins the next election.

The Italian referendum should not be seen as an isolated event, but in the context of the many long term forces at work that were also potent in the UK’s Brexit referendum and the recent US Election which will continue to fuel the rise of anti-establishment parties and candidates in the upcoming elections elsewhere (in particular, the impending referendum in Italy and general elections in 2017 in France, Germany and the Netherlands). The deep-seated voter dissatisfaction with economic and political governance is intensifying.

Newton’s thematic framework has identified the excessive debt burden as a crucial long term headwind to growth, which in turn is fuelling popular discontent with the status quo. Central Bank interventions haven’t really worked: seven years of inflating asset prices has increased inequality, without generating robust growth. From a market and portfolio perspective the general conclusions remain the same: there should be a premium on strong balance sheets and companies that can generate good cash flows, where the business model doesn’t depend on the continuation of cheap money policies. Once again, this should underline the value to investors of being globally diversified whilst being stock-selective.