Volatility expected as Italians vote ‘no’ in referendum

Dec 5th, 2016 | By | Category: Equities

With nearly a 70% turnout and around 60% of voters opting for a “no”, Italy firmly rejected constitutional reform that would have removed power from the Senate and left the Lower House as the key legislative Chamber in Italy. Prime Minister Matteo Renzi has already confirmed he will tender his resignation.


Italian Prime Minister Matteo Renzi has already confirmed he will tender his resignation.

Markets have thus far deferred going into crisis mode over the result, partly because the outcome was expected (based on polls) and therefore to some extent priced in – ETFs such as the Lyxor FTSE MIB UCITS ETF (Euronext: MIB) or the iShares FTSE MIB UCITS ETF (Borsa Italiana: IMIB) are down approximately 18% year-to-date.

The relative calm may also be due to the role the European Central Bank is expected to play in troubled markets.

ETFs tracking broad eurozone or European exposures have thus traded relatively flat since the result. These include ETFs such as the €660m Amundi MSCI EMU UCITS ETF (Euronext: CMU) or the €4.7bn iShares STOXX Europe 600 UCITS ETF (Xetra: EXSA).

The result is still troublesome for Italian assets however, as Nicola Mai, Head of European Sovereign Credit Research at PIMCO, notes: “First, the reform’s failure means that Italy has lost an opportunity to make its political system leaner and more conducive to reforms. Second, Renzi’s resignation is likely to lead to a period of higher political uncertainty which comes in the midst of ongoing recapitalization efforts in the Italian banking sector.”

The country is also facing structural problems affecting its ability to generate meaningful long-term economic growth. Unemployment remains high and much-needed labour reforms have not been forthcoming. The country’s sovereign debt pile is also problematic – according to analysis from WisdomTree, Italy’s nominal GDP growth must exceed well over 2.5% to outgrow new debt accumulation, assuming state savings remain the same. This outcome seems challenging due to the vote against the reforms.

Viktor Nossek, Director of Research at WisdomTree in Europe, commented: “We expect investor sentiment to sour and the credit rating agencies to downgrade Italy’s sovereign rating if the stresses on banks intensify, instigating a marked sell off of these debt securities,” he said. “Spreads of BTPs over Bunds are prone to widen as a politically charged environment leaves no scope for budgetary restraint.”

At the time of writing, 10-year Italian Government Bond Yields had increased slightly to 2.037%.

The referendum has also opened the door wider for Euroscepticism both within Italy and, especially if a financial crisis leads to contagion through the continent, across Europe in general. According to Michael Metcalfe, Global Head of Macro Strategy at State Street’s Global Markets division: “The no vote increases the chances of an Italian election in 2017, which given the popularity of the Five Star movement and their views on Europe, means that Italian assets will now attract an additional risk premium.”

Antoine Lesné, EMEA Head of ETF Strategy at SPDR ETFs, added: “This vote paves the way for further rejection votes in Europe and reminds us of the political headwinds that 2017 will bring. Volatility management remains necessary for long term portfolio construction in face of such events.”

With the no vote likely to drive continued market volatility in the short term, and add to bearish pressure on the euro, Italian asset classes and European risky assets in general, WisdomTree’s message to investors is to be prepared: hedge your broad exposure in equities, underweight the financials sector, and think about retreating to safe havens like gold.

To reduce exposure to financials, investors may wish to consider the iShares EURO STOXX 50 ex-Financials UCITS ETF (LON: EXFN). It has €72m in AUM and a total expense ratio (TER) of 0.20%. It is down 2.2% year-to-date compared to -4.5% for the EURO STOXX 50 Index.

The referendum result is likely to lead to an uptick in demand for low volatility ETFs, which select and weight constituents in such a way as to minimise total portfolio volatility. These strategies have become increasingly popular lately due to major geopolitical events such as Brexit. ETF providers offering such funds with European exposures include Lyxor, Ossiam, SPDR ETFs and iShares.

For those seeking the sanctuary of gold’s safe haven status, an investment in physical gold can be attained through the Source Physical Gold ETC (LON: SGLD), TER – 0.29%, or the ETFS Physical Gold ETP (LON: PHAU), TER – 0.39%.

Longer term, however, WisdomTree’s Nossek sees an opportunity in the referendum result. “European exporter stocks should benefit from a euro devaluation to the extent that it is controlled and not feeding into outright risk-off positioning by investors.”

The WisdomTree Europe Equity UCITS ETF (LON: HEDG) tracks European-listed firms which derive at least 50% of their revenue from countries outside of Europe. The fund’s constituents are dividend-weighted to increase the income yield for investors. It has a TER of 0.32%.

Alternatively the Source STOXX Eurozone Exporters UCITS ETF (Xetra: EZEX) selects eurozone companies with at least 50% of their revenues earned from outside of the region. Its TER is 0.35%.

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