The Italians will Sunday head to the polls in an election that has been flagged as the sort of political event with the potential to rattle the eurozone and shake up financial markets, while catapulting a colorful former prime minister, Silvio Berlusconi, back into power.
The biggest threat? The euroskeptic 5 Star Movement team could team up with the far-right Lega Nord to create an antiestablishment coalition that could throw Italy’s tenuous finances further into disrepair and distance the southern European country from the EU and the eurozone.
Analysts, however, overall see a less-than-10% chance of such a dire outcome. But that doesn’t mean investors should ignore the risk, according to strategists at UBS.
“Our central case does not factor in any macro or political shock; however, we cannot fully rule out tail risk, which could trigger 10-15% downside for Italian equities relative to Europe,” they said in a note on Friday. (“Tail risk” is a term commonly used by industry professionals to describe an event that has a relatively low probability of occurring.)
Against that outlook, the Swiss bank has compiled a list of stocks that offer both protection against a political blowout and the potential to rise after a more market-friendly outcome. Those stocks include oil giant ENI SpA ENI, -1.43% utility Enel SpA ENEL, -2.20% banks Intesa Sanpaolo SpA ISP, -2.16% and Banco BPM SpA BAMI, -2.14% eyewear maker Luxottica Group SpA LUX, -0.62% and Inwit SpA INW, -2.61%
The list is tilted toward four themes, UBS explained:
- Large caps, because they are less exposed to potential market shocks and have stronger liquidity.
- International champions, because they are less sensitive to a potential slowdown in the Italian economy after the election.
- Banks, because they would benefit from a rise in interest rates.
- Companies with strong balance sheets, because they would suffer less should interest rates spike after a political shock.
On the flip-side, the UBS strategists singled out a trio of stocks to avoid ahead of the vote, due to their significant exposure to the domestic economic and their higher debt burdens. They include Telecom Italia SpA TIT, -2.05% utility Terna SpA TRN, -2.15% and gas infrastructure company Snam SpA SRG, -2.15%
Opinion polls point to a murky result on March 4, indicating a stalemate between the main parties. The 5 Star Movement looks set to win the most votes; but because of a new electoral law that favors coalitions, the populist party is seen as unlikely to be able to form a government.
The currently ruling Democratic Party is slated to come in second, while Berlusconi—shrugging of his bunga-bunga sex scandal—is seen leading his Forza Italy party to a third place.
That would likely to lead to four different scenarios after the election, according to UBS:
- A grand coalition led by the Democratic Party and Forza Italia. This would in theory secure a continuation of the current policies and is seen as one of the most market friendly outcomes. UBS points out that one downside to this constellation is that it effectively leaves the role of the opposition almost entirely in the hands of the antiestablishment 5 Star Movement and the anti-immigrant Lega Nord.
- A centre-right coalition consisting of Forza Italia, Lega Nord and other right-wing parties such as the Brothers of Italy. Because of Berlusconi’s tendency to surprise to the upside in Italian elections, UBS says this coalition looks like the most likely outcome. However, because of the parties’ widely different stances, especially on foreign affairs, this alliance may not last long, the Swiss bank points out.
- A government led by the 5 Star Movement. The euroskeptic party has previously vowed to hold a EU referendum, stoking fears of an “Italexit”—Italy’s exit from the eurozone. However, its leader has recently backtracked on this, calming fears of a breakup of the currency union. The 5 Star Movement may struggle to get support from other parties, making this option the least likely.
- A hung parliament and new elections. Since no party is expected to win an outright majority, a hung parliament where no party can form a government is also considered a likely outcome. This could lead to new elections soon after, according to UBS.