In 2016, three political events mark the world financial markets as no other one: the Brexit referendum, the US presidential election, the Italian constitutional referendum. While the first two have gone, fortunately not leading to the mayhems that many had feared, the Italian one, scheduled for December 4, remains a big question mark. [...] What will happen is that a number of investors with strong nerves and deep pockets will remember these 2016 weeks as those which one does not see often in a life time. As recently written (August 8, “In times of forced stress, the Italian bankers find some relief in their Atlante”), I think that Italian banks have reached their bottom and despite the “further tough times on the way upwards [which] cannot however be ruled out”, the time of the constitutional referendum is the time for finally starting to shape a new Italy. And banks will mirror this (as they have mirrored, so far, the problems of the old Italy).

1. Italy’s referendum will mark the start of a new Italy (as
banks will show)
In 2016, three political events mark the world financial markets as no other one: the
Brexit referendum, the US presidential election, the Italian constitutional referendum.
While the first two have gone, fortunately not leading to the mayhems that many had
feared, the Italian one, scheduled for December 4, remains a big question mark.
One could say that while the two Anglo-Saxon countries chose a new course, with all
the benefits of the doubt (as markets witnessed in the aftermath of the vote), the
Latin country could choose a course that, whatever the outcome, will see significantly
different market developments, with euphoria in one case vis-a-vis depression in the
other. So the widespread view about what will happen next.
Given that the former two views turned out to be incorrect, once the events took
place, one could expect that the outcome of the Italian referendum will follow suit. For
the sake of some completeness, one must say that both the Brexit referendum and
the US elections changed many things – and still are in the process of changing
many things – but fortunately not with the market crashes that many feared.
With regard to the Italian referendum, the financial markets have already showed in
these last three months on which side they are: the more the “no front” to the Italian
reforms is said to be leading the voting intention polls, the more the most sensitive
financial indicators of the country turn negative. Just consider these two:
(i) the yield spread between the 10-year government bonds of Italy (BTP) and
Germany (Bund) has reached these days the 200 bp level vis-à-vis less
than 120 bp in August (and 99 bp on December 31, 2015);
(ii) the index of the Italian banking stocks has lost 13% while the equivalent
European index has gained 3% in the month starting October 27, thus
wiping away most of the gains of late summer / early autumn.
The point is if these two indicators can further weaken. For sure they can but
presumably not as much as a “no” response could suggest. There are two
perspectives to take into account: a financial one and a political one.
The financial perspective – with regard to the bonds – deals with the ECB’s
Quantitative Easing program (QE) which is in full swing (with EUR 80 bn bond
purchases per month) while – with regard to the banking stocks – deals with
valuations that continue to be so cheap as never before, with price-to-book value
ratios amply below 1.0x, with troughs of 0.3x. In such a context, is an investor ready
to go short on the Italian bonds and/or the Italian banking stocks? I personally would
not: the eventual gains are not there to stay.
The political perspective boils down to the question if, in the assumption the “no”
camp has won, the country will be manageable or not. The events of the last three

2. decades show that Italy is stronger than any counter-wind it could face (despite all
the problems that this however meant). This to say that the eventual resignation of
the Renzi government, which is the natural development of a “no” win, will not lead to
any “high risk, high mess” situation. There are good reasons to think that the ones in
charge know how to handle this outcome: a country with a debt load of more than
EUR 2,200 bn (133% of its gross domestic product) is no longer in a position to have
governments which just “keep afloat”.
In addition to the consideration just made, some Italian banks need fresh capital
injections: Monte dei Paschi di Siena is the first name on this list (the capital increase
must be closed by year-end), some regional banks will probably follow and even
UniCredit is rumored to take this ignominious step in order to make its new start (!). It
is therefore a political priority that the banks under restructuring could find acceptable
market conditions. As must be clear, it is Italy itself that in the end could eventually be
at stake, a scenario which any responsible person must avoid.
The snag with this referendum is that it has been “personalized”: many Italians view it
as a vote on Matteo Renzi and his government, not on the merits of the question that
voters will face at the polling station. As a result, many opponents of Renzi – even in
the ranks of his own party! – see in the referendum the long-awaited occasion to sack
the smart young man from Florence and to try to go back to the old practices: not
really what the country needs. The bitter lesson is that, once again, Italy could not get
rid of its century-old habit of creating a conflict situation in its own territory, in which
one side is put against the other side, no matter what the issue is.
The issue is the binary option between a new Italy and an old Italy, not between “yes
to Renzi” and “no to Renzi”. The old Italy has long shown what it can:
 it has led to 64 governments since 1948 (the year in which the Italian
Constitution came into force);
 the supposed “stability” of the system – as some evergreen nostalgic voices
call it, considering the post-war dominance of the Christian Democratic party
(1948-1994) - has led to a country unable to cope with the challenges of the
globalization, as witnessed by almost inexistent productivity gains since 1995:
in the period 1995-2015 productivity per hour increased 5% in Italy vs 30% in
France, Germany, Great Britain and vs 15% in Spain;
 it has presided over the explosion of the public debt, which doubled in the
Eighties, moving from around 50% of GDP at the end of the Seventies to
almost 100% at the end of the decade, then adding further 20 percentage
points before the harsh correction measures requested by the participation in
the euro project (the 20-percentage point correction was however rapidly
cancelled as a consequence of the outbreak of the 2007 financial crisis).
If these are the outcomes of the old Italy (just to name the most remarkable three of a
long list), the new measures proposed with the referendum cannot change the
country for the worse. The intention is:

3. (a) to get rid of the so-called “perfect bicameralism”, i.e. a system in which both
houses of parliament (the so-called “Camere”, the “Chambers”) have the same
powers thus hampering the legislative process (the Senate would thus lose its
legislative authority and would be transformed into an advisory body, made up of
representatives of the local administrations, i.e. regions and municipalities);
(b) to reduce the members of the parliament of 215 out of a total of 945, since the
new Senate would count 100 members and no longer 315 (currently there are also 7
so-called “senators for life”);
(c) to trim the costs of the political system of an amount far beyond both the salaries
of the senators no longer in office as well as the expenses of the consulting agency
CNEL (Consiglio Nazionale dell’Economia e del Lavoro), which will be abolished;
(d) to amend the part of the constitution (the so-called “Section V of part II”) which
involves the powers of the regions. It went through significant changes in 2001 but
the supposed advantages (more local power) never materialized, being the expenses
disconnected from the revenues (in too many cases Italy’s central administration had
to come to the rescue of inefficient local administrations).
Some critics say that this constitutional referendum is not what Italy needs,
highlighting the risks that the country could face should these reforms take place in
combination with the new electoral law aimed at guaranteeing the major party full
legislative power. Hence the not really particularly bright suggestion for a so-called
“technocratic caretaker government”, which should solve “as many times in the past”
Italy’s current standstill moment. It is a suggestion that reminds of too many failed
attempts – in any case of attempts which did not live up to their promises (just think
about the pension reform or the reduction of the public debt).
And similarly it reminds of too many wrong predictions, those describing many Italian
banks as close to collapsing. It will not happen. What will happen is that a number of
investors with strong nerves and deep pockets will remember these 2016 weeks as
those which one does not see often in a life time. As recently written (August 8, “In
times of forced stress, the Italian bankers find some relief in their Atlante”), I think that
Italian banks have reached their bottom and despite the “further tough times on the
way upwards [which] cannot however be ruled out”, the time of the constitutional
referendum is the time for finally starting to shape a new Italy. And banks will mirror
this (as they mirrored, so far, the problems of the old Italy).
November 29, 2016