sign in sign up
<<
Home , Hung parliament, Matteo Renzi, Paolo Gentiloni, Team Autonomies, The Autonomy

FEB Market Update 2018

Italy’s (Definitely Complicated) Election

Giuseppe Ricotta, CFA, FRM, Senior Vice President, Portfolio Manager/Analyst Guillaume Samama, CFA, Vice President, Research Analyst

Italy’s political future was thrown into doubt a little over a year ago after the then-Prime resigned following the electorate’s rejection of the constitutional reforms he had championed (for details see our Lazard Market Update, Comments on the Italian Result). We believe the referendum was a missed opportunity for positive reforms and that the next , scheduled for 4 March this year, could be pivotal for the country’s direction. In this paper, we discuss the election, the new electoral system, the potential for a hung and other risks, and potential election scenarios. We use scenario analysis, conducted by our Multi-Asset team, to gauge the market reactions and economic implications for investors. A Missed Opportunity From 2014 to 2016, under the leadership of the centre-left (PD) and Prime Minister Renzi, Italy’s budget deficit remained well below the ’s (EU) headline target of 3.0% of GDP, and the labour market and banking sector underwent a series of transformations. The constitutional reform, to which Renzi staked his political future, represented an opportunity to drive reform efforts . The proposed constitutional reforms of 2016 would likely have made it easier and faster to pass new laws, as it would have lessened the Senate’s law-making powers and introduced several new paths to enact laws. We regarded these reforms as potentially transformational and, in our view, they would have been a positive step for Italy, in contrast with the present situation in which the (or Chamber of Deputies) and the Senate—which comprise Italy’s parliament—have equal voting powers. At present, all laws have to be approved by both chambers, which often results in a bill being passed back and forth between the two, making it difficult to approve key reforms and, in some cases, altogether preventing their adoption. The electorate rejected the referendum and, in October 2017, the government passed a new law governing how the members of the Lower House and the Senate (which continue to have equal powers) are elected. Under the new electoral system, it is possible for a party or to win the popular vote and command a comfortable majority in the Lower House, while at the same time winding up with slim support, or perhaps even being in the minority, in the Senate. Although we think that the proposed constitutional reform was a missed opportunity, Italy’s next government has a crucial role to play in deciding the country’s direction.

The New Electoral System Exhibit 1 Italy’s Main Political Parties Votes at the upcoming general election will be cast under the new electoral system for the first time. The Party Ideology Leader new system is a hybrid of two electoral systems—first- Free and Equal (LeU) Left past-the-post and proportional representation—and is Democratic Party (PD) Centre-Left Matteo Renzi intended to promote political stability. In recent years, (FI) Centre-Right no single party (Exhibit 1) or coalition has managed Northern League (LN) Right to win an outright majority in Italy, giving rise to the (FdI) Right formation of grand coalitions after each election. 5 Star Movement (M5S) Anti-Establishment

Source: Chamber of Deputies of the , Lazard

LR29759 2

While it is set to be tested for the first time on 4 March 2018, Exhibit 2 the new system encourages parties to build pre-election alliances Support for the Ruling Democratic Party is Waning and also favours locally well-established parties. For this reason, (%) the anti-establishment (M5S), with its 35 populist policies and Eurosceptic views, is expected to be at a disadvantage despite its lead in the polls. 30 M5S Although the M5S has recently softened its stance on forming 25 PD pre-election coalitions—having been vehemently against 20 it in the past—few parties have been willing to ally with it. FI Furthermore, despite its strong showing in national polls 15 LN (Exhibit 2), M5S does not generally have strong support at the 10 local level, as reflected by recent municipal election results. LeU 5 In the Sicilian regional election in November 2017—considered FdI 0 by some to be a barometer of Italy’s general election—centre- Jan 2017 May 2017 Sep 2017 Jan 2018 right parties made strong gains, trumping both the M5S and As at 8 February 2018 the centre-left PD. The election result was a blow to the ruling Source: Quorum, YouTrend centre-left government and some expect the same could happen in the upcoming general election, given that support for the PD has been waning in recent weeks as M5S and Silvio Berlusconi's Exhibit 3 centre-right Forza Italia (FI) have gained ground. Centre-Right Coalition Gains Ground

(%) While polling trends could change in the weeks ahead of the Centre Right election, or indeed completely misjudge the outcome, as has 40 been the case with key elections in other countries in recent 35 years, current projections indicate that a centre-right coalition M5S 30 could far outstrip both a centre-left coalition led by the PD and Italy’s most popular party, M5S (Exhibit 3). 25 Centre Left 20 A ? 15 Despite the revamping of Italy’s electoral system to make the 10 country more governable, the three-way political gridlock Left indicated by polls suggests that no formation is likely to secure a 5 majority. If the polls are accurate, the election results will likely 0 Jan 2017 May 2017 Sep 2017 Jan 2018 be inconclusive (Exhibit 4). To achieve an absolute majority, a party or coalition must secure at least 316 seats of 630 total in As at 8 February 2018 Source: Quorum, YouTrend the Lower House. While some regard an inconclusive election as the least market- friendly result—it could potentially lead to months of political Exhibit 4 uncertainty—investors could also be encouraged if anti- Increased Likelihood of a Hung Parliament establishment parties are marginalised. Italy: Seat Projections

The Fear of Populism Five Star Movement Centre-Right (M5S) FI-Lega-FDI (to be allocated) Voters’ rejection of Italy’s constitutional reform in December 170 2016 raised concerns that the populist M5S could gain power. Democratic 131 Party (PD) Since then, we would argue that this risk has receded, partly 170 Forza Italia 107 Berlusconi 266 aided by Italy’s . We believe that the new voting Centre-Left 68 PD & Allies (to Lega system puts M5S at a disadvantage heading into the election 47 154 be allocated) 51 Salvini given its lack of traction at the local level and questions around LeU (Left) 27 27 16 Brothers its ability to team up with other parties. Furthermore, M5S has Total: 617 Seats* of Italy also softened its stance on holding a referendum on Italy’s (FDI) membership if it were to come to power, shifting its rhetoric as As at 18 January 2018 public support for the single currency has risen in Italy and in *Valle d’Aosta and Overseas constituencies are excluded The proportion of seats attained via first-past-the-post allocation and via proportional the euro zone (Exhibit 5). allocation will influence the overall number of seats achieved. Source: Ipsos Public Affairs Italy 3

Exhibit 5 Potential Election Scenarios The Euro Is Gaining Popularity We have identified five primary potential outcomes for the Do you think that having the euro is a good or bad thing for your election (Exhibit 6) and their implications (Exhibit 7). Our country? base case for Italy’s economic and investment landscape over A Good Thing the next six-to-twelve months is evenly balanced to the upside and downside, although we believe the probability of a left-tail (%) 70 negative outcome to be 10 percentage points higher than that of Euro Zone a right-tail positive outcome (Exhibit 8). The probabilities are

60 based on the Lazard Multi-Asset team’s analysis conducted as of end-January 2018. 50 Based on current polls, even a between Renzi’s Italy PD and Berlusconi’s FI seems unlikely to be able to form a 40 2012 2013 2014 2015 2016 2017 majority, unless it is supported by some of the smaller parties from and the left. However, Renzi and Berlusconi could A Bad Thing reach an agreement to temporarily keep current Prime Minister (%) in office for a few more months, paving the way 50 for a technocratic government. A technocratic government could Euro Zone then be tasked with pushing ahead with much-needed structural 40 reforms, such as reforming the judicial system, modernising the and further market liberalisation. 30 Italy The Need for Reform 20 2012 2013 2014 2015 2016 2017 Italy does face the possibility of repeat elections in a potential

As at 31 October 2017 hung parliament scenario, which could significantly delay the Source: ’s Eurobarometer Flash survey about the views and formation of a new government. This could result in successive attitudes related to the euro in the 19 euro area countries. elections being called or a less stable government eventually coming to power. While Germany has been without a formal The Threat of Populism Is Not the Only government for months following an inconclusive federal election in September of 2017, it has navigated the political Risk deadlock and emerged relatively unscathed. However, Italy’s Other Eurosceptic parties in Italy—such as the Northern fiscal position is very different from Germany’s. League—have followed M5S’s lead by focusing on migration Although Italy’s economic performance exceeded expectations policy, rather than on the euro, in a bid to win the populist vote in 2017, the country remains one of the most indebted in the as has grown to become one of the biggest issues euro zone, second only to . Italy’s government debt as a for voters not only in Italy but also in the EU. Given these percentage of GDP currently stands at around 135%1, while its factors, we believe that the risk of Italy abandoning the euro has rate is the fourth-highest2 in the single-currency diminished and, as such, do not expect the upcoming election to bloc. It is also one of the slowest-growing economies among the revive “Italexit” concerns. EU’s big four—Germany, France, Spain, and Italy. However, other risks remain, including the prospect of fiscal Italy, ’s third-largest economy, has made some strides with deterioration, a slowdown in the pace of structural reforms, reform, particularly in revamping its labour market. However, and a push to renegotiate EU treaties—all of which are strong more needs to be done in order for Italy to close the growth gap possibilities given the pre-election rhetoric of several parties, with its euro zone peers, including ongoing efforts to reduce the both from the centre-right and the centre-left. These risks could large stock of Italian banks’ non-performing loans and improve grow if the new government arises from a cross-party coalition in the country’s productivity and investment growth. We continue which individual parties fail to agree on fiscal policy and needed to believe that Italy also needs to enact a comprehensive reform of economic reforms. The outcome of Italy’s upcoming general the judicial system in order to make it faster and more efficient3. election—and the possibility of these risks emerging—will be In our view, it would be a crucial step to help modernise the dictated not only by voter preferences but also by each party’s country, make it more globally competitive, and attract business strategic behaviour. investment. A protracted political impasse could jeopardise Italy’s progress and set it on a different path at a time when the has started to gradually withdraw its stimulus. 4

Exhibit 6 Potential Election Scenarios

Is a centre-right coalition able to secure a majority? No (70%) Yes (30%)

The president asks the leading party (currently M5S) The president asks the centre-right coalition to try to to try to form a coalition form a government

Is M5S able to successfully form a coalition? Which party has more seats – Forza Italia or Northern League?

Forza Italia Northern League Yes (10%) No (60%) (20%) (10%)

A B C Luigi Di Maio becomes PM Silvio Berlusconi selects PM Matteo Salvini becomes PM

Is the centre-right able to create a grand coalition with the Democratic Party and/or other parties?

Yes (40%) No (20%)

D E Silvio Berlusconi and Matteo Renzi Fresh elections select PM are called Current Prime Minister Paolo Gentiloni could remain PM

Technocratic government could follow

As at 26 January 2018 Source: Lazard

Exhibit 7 Potential Implications

Outcome Potential Market Reaction Scope of Potential Reforms Potential Fiscal Impact Potential Economic Impact A M5S wins absolute Negative Labour market reform, Negative Negative majority Pension reform, Judicial reform, Renegotiation of EU treaties B Centre-Right Coalition: Short-term positive, No significant reforms Short-term negative, Negative Forza Italia selects the PM long-term negative expected long-term neutral

C Centre-Right Coalition: Negative Labour market reform, Negative Short-term neutral, Northern League Pension reform, long-term negative selects the PM Judicial reform, Renegotiation of EU treaties

D Grand Coalition: Short-term positive, Asset repossession reform, Neutral Short-term positive, Democratic Party and long-term neutral Electoral reform long-term neutral Forza Italia select the PM Technocratic Government ­— Judicial reform, modernising the Long-term positive Long-term positive public administration and further market liberalisation E Repeat Elections Negative Short-term neutral, Short-term neutral, Short-term neutral, long-term dependent on duration long-term dependent on long-term dependent on of political hiatus duration of political hiatus duration of political hiatus

As at 26 January 2018 Source: Lazard 5

Exhibit 8 Current Market Forecast for Italy (Probabilities)

Deteriorating Slow, uneven Sustainable, Overheating conditions 15% growth 40% healthy growth 40% conditions 5% Bear Base Bull

As at 26 January 2018 Our Market Forecast is based on an evaluation of returns and risks across four subject areas: the macro economy, asset valuation, market liquidity, and investor sentiment. Our process seeks to assess the future state of each area and assigns probabilities to potential outcomes ranging from bearish to bullish. Source: Lazard

One of the Greatest Risks Is Prolonged Delay Italy is accustomed to political flux. It has had 65 governments since World War II and five in the past seven years alone. Italians have also grown accustomed to unelected governments. The current prime minister, Paolo Gentiloni, was appointed in December 2016 and was the fourth unelected prime minister in a row. As such, we do not regard a hung parliament as the worst potential outcome. Indeed, we believe there is scope for a relief rally in Italian financial assets as we expect investors could shift their focus to the weakened position of anti-establishment parties. The potential for a prolonged delay in forming a government in the event of an inconclusive election is one of the greatest material risks, in our view. This could result in a succession of elections or a less stable government eventually coming into power and, with it, the higher risk of fiscal deterioration, a slowdown in the pace of reforms, and a determination to renegotiate EU treaties. Lazard’s Multi-Asset team market forecast is based on an evaluation of returns and risks across four subject areas: the macro economy, asset valuation, market liquidity, and investor sentiment. Our process assesses the future state of each area and assigns probabilities on a forward-looking basis (six-to-twelve months) to potential outcomes ranging from bearish to bullish.

About the Author Giuseppe Ricotta Senior Vice President Portfolio Manager/Analyst Lazard Asset Management Limited Giuseppe Ricotta is a Senior Vice President and Portfolio Manager/Analyst on Lazard’s Multi-Asset investment team, focusing on macro research and portfolio construction. Prior to joining the Multi-Asset investment team, Giuseppe worked in Marketing, where he led several projects for the strategic marketing of Lazard’s investment strategies. He began working in the investment field in 2004. Prior to joining Lazard in 2007, he worked at American Express Bank, where he was a senior manager responsible for institutional marketing and sales support for the firm’s offshore funds platform. Prior to that, he worked at the Telecom Italia Group. Giuseppe has an MBA (Hons) from Fordham University and an MS (Summa Cum Laude) in Electronic Engineering from the University of Palermo in Italy.

About the Author Guillaume Samama Vice President Reasearch Analyst Lazard Asset Management Limited Guillaume Samama is a Research Analyst primarily covering the Financial sector. He began working in the investment field in 2010. Guillaume worked for Lazard as an intern and subsequently joined the firm in 2010 after graduating from EDHEC Business School. He has a Master of Science in Risk and Asset Management and Master in Management from EDHEC Business School. Market Update

This content represents the views of the author(s), and its conclusions may vary from those held elsewhere within Lazard Asset Management. Lazard is committed to giving our investment professionals the autonomy to develop their own investment views, which are informed by a robust exchange of ideas throughout the firm.

Notes 1 Source: . As at 29 September 2017. 2 Source: Eurostat. As at 31 December 2017. 3 The time needed to resolve litigious civil and commercial cases in Italy was among the highest of any EU member state in 2015, taking around 530 days to resolve a case in court (meaning the time taken by the court to reach a decision at first instance). Source: EU Justice Scorecard, Based on the European Commission for the Efficiency of Justice study 2017.

Important Information Published on 15 February 2018. Information and opinions presented have been obtained or derived from sources believed by Lazard to be reliable. Lazard makes no representation as to their accuracy or completeness. All opinions expressed herein are as of the published date and are subject to change. This document is provided by Lazard Asset Management LLC or its affiliates (“Lazard”) for informational purposes only. Nothing herein constitutes investment advice or a recommenda- tion relating to any security, commodity, derivative, investment management service, or investment product. Investments in securities, derivatives, and commodities involve risk, will fluctuate in price, and may result in losses. Certain assets held in Lazard’s investment portfolios, in particular alternative investment portfolios, can involve high degrees of risk and volatil- ity when compared to other assets. Similarly, certain assets held in Lazard’s investment portfolios may trade in less liquid or efficient markets, which can affect investment performance. Past performance does not guarantee future results. This document is intended only for persons residing in jurisdictions where its distribution or availability is consistent with local laws and Lazard’s local regulatory authorizations. The Lazard entities that have issued this document are listed below, along with important limitations on their authorized activities. Australia: Issued by Lazard Asset Management Pacific Co., ABN 13 064 523 619, AFS License 238432, Level 39 Gateway, 1 Macquarie Place, Sydney NSW 2000, which is licensed by the Australian Securities and Investments Commission to carry on a financial services business. This document is intended for wholesale investors only. Canada: Issued by Lazard Asset Management (Canada) Inc., 30 Rockefeller Plaza, New York, NY 10112 and 130 King Street West, Suite 1800, Toronto, Ontario M5X 1E3, a registered portfolio manager providing ser- vices to non-individual permitted clients. Dubai: Issued and approved by Lazard Gulf Limited, Gate Village 1, Level 2, Dubai International Financial Centre, PO Box 506644, Dubai, . Registered in Dubai. International Financial Centre 0467. Authorised and regulated by the Dubai Financial Services Authority to deal with Professional Clients only. EU Member States: Issued by Lazard Asset Management (Deutschland) GmbH, Neue Mainzer Strasse 75, D-60311 Frankfurt am Main. Hong Kong: Issued by Lazard Asset Management (Hong Kong) Limited (AQZ743), One Harbour View Street, Central, Hong Kong. Lazard Asset Management (Hong Kong) Limited is a corporation licensed by the Hong Kong Securities and Futures Commission to conduct Type 1 (dealing in securities) and Type 4 (advising on securities) regulated activities only on behalf of “professional investors” as defined under the Hong Kong Securities and Futures Ordinance (Cap. 571 of the Laws of Hong Kong) and its subsidiary legislation. Korea: Issued by Lazard Korea Asset Management Co. Ltd., 10F Seoul Finance Center, 136 Sejong-daero, Jung-gu, Seoul, 100-768. People’s Republic of : Issued by Lazard Asset Management. Lazard Asset Management does not carry out business in the P.R.C. and is not a licensed investment adviser with the China Securities Regulatory Commission or the China Banking Regulatory Commission. This document is for reference only and for intended recipients only. The information in this document does not constitute any specific investment advice on China capital markets or an offer of securities or investment, tax, legal or other advice or recommendation or, an offer to sell or an invitation to apply for any product or service of Lazard Asset Management. Singapore: Issued by Lazard Asset Management (Singapore) Pte. Ltd., 1 Raffles Place, #15-02 One Raffles Place Tower 1, Singapore 048616. Company Registration Number 201135005W, which provides services only to “institutional investors” or “accredited investors” as defined under the Securities and Futures Act, Chapter 289 of Singapore. : Issued or approved by Lazard Asset Management Ltd., 50 Stratton Street, London W1J 8LL. Registered in England Number 525667. Authorised and regulated by the Financial Conduct Authority (FCA), providing services only to persons classi- fied as eligible counterparties or professional clients under the rules of the FCA. : Issued by Lazard Asset Management LLC, 30 Rockefeller Plaza, New York, NY 10112.