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Prospect of Snap Election in Italy Spooks Equity Markets

Widespread approval from Italy’s main political parties on a new electoral law could bring forward a parliamentary vote as early as September. Some investors seem to think this unprecedented move could further spook European equities. Robert Mazzuoli, portfolio manager, Franklin Local Asset Management, European Equities, thinks the change in Italian electoral law and the prospect of new political leaders in the three major eurozone countries—France, Germany and Italy—could offer investors a chance to take a step back and examine potential opportunities across Europe.

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Four of Italy’s major political parties have backed radical electoral reform in a move that experts believe heightens the chances of a general election in the country this year.

This surprise move appears to have spooked some investors, and Italian equity shares suffered in the days after the news emerged. Some observers fear wider European equity markets could also be affected.

However, we think this development could instead offer opportunities in Italian stocks in particular, should the market remain weak in the run-up to the election. And, we believe it’s the change in the electoral system that counts the most.

The reform would introduce a proportional representation voting system, similar to that used in Germany. Crucially, smaller parties would require at least 5% of the vote before being entitled to a place in parliament. The move has the support of four of the biggest political parties—the centre-left Democratic Party (PD), centre-right Forza Italia, Five Star Movement and far-right Lega Nord.

Italian lawmakers are due to discuss a draft of a law that would enact the reform next month. If they agree, fresh elections could be held as early as the autumn—the same time as German federal elections are scheduled.

Former Italian Prime Minister Matteo Renzi has spoken of his support for the change. And, he has said holding an election at the same time as the German federal election would reduce market uncertainty.

If this agreement holds, the 5% threshold means we will likely see only four parties in the next Italian parliament, which should greatly facilitate the formation of a new government with a more stable majority.

So, we think a change in the electoral law allows us to take a more constructive look at Italian stocks. With more certainty surrounding which parties will enter parliament and public backing from party leaders, we should see a reduction in political worries and market uncertainty.

Wider Implications for Europe

Looking into 2018, we are increasingly optimistic about the potential opportunities for investors in Europe. The European Central Bank is likely to remain accommodative, which we think supports our view.

Assuming Italy will vote in 2017 and gain a stable coalition, all three major euroland countries (France, Germany and Italy) will have newly elected governments. Hopefully, they can all work together for the next three to four years on EU reform following the United Kingdom’s exit. We think this could give financial markets long hoped-for political stability, the chance to mend the European project and reinvigorate growth with widespread social participation.

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