Italian referendum: What investors need to know

Christian Crete,  Portfolio Manager,  Hexavest

Montreal  - Now that the U.S. elections are in the rearview mirror, the attention has shifted to Europe and this Sunday's Italian referendum as the next big political event that could potentially shake markets.

Over the weekend, Italians will vote on whether to approve changes to the country's constitution.

The latest public polls as of November 18 (there is a poll blackout two weeks before the vote) suggested the "No" vote was leading by almost 7 percentage points, but given the large share of undecided voters, the outcome could easily sway in favor of the "Yes." The odds, however, remain largely in favor of a "No" victory.

At the beginning of the campaign, Prime Minister Matteo Renzi staked his political career on the outcome of the referendum, but he has not been has transparent in recent weeks about his resignation in the event of a "No" victory. It remains to be determined if Italy will hold a general election following the resignation of Renzi. It is highly probable that the president of the Italian republic will ask the various political parties to work together and form a coalition that would act as a "caretaker" government until the next general election in 2018.

A "No" vote increases the probability that an early general election will take place but this also means the powers of the Senate will not be abolished. This would limit the political strength of a 5 Star Movement-led government.

A "Yes" vote would boost the sentiment regarding Italian assets. This would have an important impact on the recapitalization efforts of the banking system which is a necessary development if the Italian economy is to recover further.

Beyond the referendum, the more important issue for Italy and the euro might be the election that is scheduled to take place in the spring of 2018. The new electoral law, which came into effect in July 2016, increases the probability that the 5 Star Movement political party will take control of the lower house with a win in the second round of the general election.

However, without the constitutional reforms, the party would only control the lower house and any decisions would most likely be vetted by the Senate. Under the current system, both the lower house and the Senate have relatively equal power.

Bottom line:  The macro outlook for Italy doesn't change greatly in the event of a "No" victory although investor sentiment could deteriorate further. However, we feel like much of the negative implications are already currently reflected in the equity prices. If a "No" vote wins, we feel there is more downside for the euro currency than Italian stocks.