Renzi Loses Referendum

As I projected Matteo Renzi lost the referendum. The margin of his defeat was more than the polls had indicated. He was down by the mid-single digits in the last polls, with about 20% undecided. “No” ended up winning the election by almost 20 points. The trend continues towards populist candidates winning and the undecided vote almost all going towards the populist candidate. This is an anti-globalist movement which is against the agenda of Angela Merkel and the European Union. The anti-establishment parties in Italy, the 5-Star Movement and the Northern League, are calling for early elections in 2017 which could accelerate the political path Italy is on to potentially leave the EU.

Goldman Sachs puts a 25% chance on the odds of an early election in 2017 opposed to the scheduled one in 2018. I’m expecting some snap polls to come out asking the Italians whether they support leaving the EU. Given the 20-point win “No” had, I expect leaving the EU to win those polls. Technically leaving the EU doesn’t match with a “No” vote, but I have argued against ignoring the technicalities. This argument is supported by the fact that regions and demographics that supported “No” also are right nationalists. Southern Italy voted for the 5 Star Movement in the election in 2013 and voted “No” by a wide margin in this referendum. The northeast of Italy supported the Northern League and also voted “No.” These parties lean Eurosceptic, with many politicians among them call for Italy leaving the Euro currency without necessarily leaving the EU. A referendum to leave the EU, which is what some are calling for, won’t have legal standing because Italian elections can’t change international treaties, but would pressure the government to act.

The “No” vote also did well with regions which had high youth unemployment. This signals a dissatisfaction with the status quo. Since being in the EU is a status quo vote, I’d expect youth who are unemployed to also vote against being in the EU. I see the youth vote as more passionate than other demographics because, in the short term, some of the political paths they support going down would be against their interests. The youth vote would tend to care more about long term prospects, so having a functioning government which responds to the people is more important than recapitalizing the banks to them. The “No” vote signals distrust with the current government and ‘throws the baby out with the bathwater.’ They voted against government reforms even though they supported them. It’s similar to when Democrats were claiming the GOP would oppose President Obama on everything instead of finding common ground. That statement is highly political, so you may disagree with it, but I’m simply using it as an analogy.

It’s tough to forecast what will happen in Italy which is precisely why political risk is supposed to cause volatility in equity markets. However, Trump, Brexit, and “No” have been followed by rallies in stocks. The reason why this is wrong is because each election brought uncertainty with regards to which policies would happen. Sure, it’s a positive that we know the result, but we don’t know the future of the western world given the rhetoric out of these parties which tends to be against globalization which means potentially anti free-trade, anti-political elites, and anti-immigration. Declines in global trade would be a drag on GDP growth.

The chart below shows the latest polls among the political parties in Italy. The 5 Star-Movement is in yellow and the Northern League is in green. Looking at the possibility of an Italeave, the two parties would have to form a coalition government. The decision whether to have an early election is interesting because, given the 2-year downward trend for the establishment Democratic Party, they might want an early election before they lose even more ground. On the other side, the 5 Star Movement could be peaking in popularity, so they’d want an election as soon as possible.

italianpolls

As I said, these heightened political risks are supposed to cause market volatility. However, with the central banks buying assets to avoid negative effects from spilling over, there isn’t volatility like I would expect. The ECB buying assets is why I said stocks would rally after “No” won. This is the current trend. Any bad news which is anticipated, will be bought by central banks. If stocks randomly sell-off there’s a delay in this prop up policy. As you can see from the chart below, the Swiss National Bank has been expanding its purchases of U.S. stocks recently. In my perspective, preventing minor bouts of volatility only causes bigger bouts when the volatility can’t be contained.

swiss

Matteo Renzi’s referendum is an analogy for the global monetary policy. He bet his own popularity that he’d be able to get reforms done. He thought it would be worth the risk, but he wasn’t in touch with what the citizens wanted. The central banks similarly are betting that trust in the system will never wain when they print money to support it. It is a high risk, low probability event. In essence, they are creating a black swan. Because trust in the system is what will catalyze this policy to end, political risk has a high probability of causing it to break down. Asset purchases have a disproportionate impact on the rich, but if a large helicopter money policy was proposed it may create hyper-inflation. This is the choice central bankers must make. Either they allow populism to grow in power which may go after their policies or they can try to quell unrest by doing helicopter money which could sever trust in the system.

Conclusion

            As I projected “No” won the referendum. The trend towards populism is even stronger than I thought because it won by 20 points and the voter turnout was very high. Turnout was 65.5% compared to the 2006 referendum which received turnout of 52.3%. If high turnout favors populist results in Italian elections, then a referendum to leave the EU stands a high chance of being approved given Brexit generated a 72.2% turnout. As I said, this referendum wouldn’t directly cause Italeave because treaties cannot be voted on in a referendum, but it would make it even more likely

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