Fading Fundamentals and Political Dysfunction Foreshadow Italian Disaster

Although the Euro Area may be limping along and showing some modest gains on the fundamental front, certain individual countries continue to struggle to find the silver lining, chief among them being Italy. Between governments that rarely survive more than a year and systemic economic problems that remain unresolved, the outlook for Italy continues to sink. With the latest decision by the Constitutional Court to invalidate the voting system, the likelihood of greater political chaos and weak governing coalitions make fiscal change an even more distant hope.

With all the political problems distracting from the growing problems facing the real economy, actual reform will continue to prove elusive, increasing the negative impact on overall fundamentals. The best evidence is the worsening sentiment among investors, which pushed the yields on Italian government bonds to the highest point in six weeks as confidence in the outlook fades. Given the very fractured backdrop, the FTSE MIB, which has given a strong performance over the last few months, is likely to see its latest grind higher quickly reverse as the outlook deteriorates.

The Slow Grind

As usual, politics in Italy is moving as slow as molasses, with the latest ruling from the nation’s highest court paving the way for a new set of elections. The 5-Star Movement, led by former comedian Beppe de Grillo, is calling for elections as soon as the summer, nearly a year ahead of schedule. However, despite their growing traction with their populist calls, the extreme divisiveness of Italian politics means that no party will hold a majority, making a fractured coalition a likely outcome. As a result, investors have sold Italian bonds, pushing yields well above comparably Euro Area levels. However, the biggest problem associated with political gridlock is that no new economic reforms can be pushed through.

The result is an unemployment rate that stands at 11.90%, well above the Euro Area average. Without fiscal and structural reform, growth is also likely to remain softer. The icing on the cake is weaker consumption and inflation, all of which bode poorly for the broader growth outlook. Retail spending figures released on Thursday showed that monthly sales for November contracted by -0.70%. Although the headline annualized figure managed to rebound to positive territory, much of the gains are likely due to rebounding energy costs. Taking all these factors into consideration, it is surprising that the Italian MIB equity benchmark has not exhibited a worse performance over the last year.

Luckily for Italian equity investors, the ECB remains a powerful force behind index returns as their supportive stance helps drive investors towards higher yielding assets like stocks. The maintenance of the asset purchase program and extension through December should remain relatively, if albeit artificially, supportive of stocks over the medium-term. However, tapered purchases coming in April could see some of the momentum higher wane. Furthermore, as a leading indicator, any drop in the MIB is likely to precede weakness in the broader economy.

MIB on a Knife Edge

After the disappointing retail figures and court decision, the MIB has been on the slide despite positive traction in global equities following the Dow futures close above 20,000. While most benchmarks have been on the climb, the worsening outlook for Italian politics and the economy are combining to weigh on investor sentiment. From a technical perspective, the latest price action suggests a horizontal range may be forming, or still yet, a reversal may be in play. Resistance at 19770 has been a formidable level, potentially forming the upper end of the range with support at 19120 creating the lower end of the range. Another test of each of these levels without a break implies a range is in play.

However, aside from the range, the most recent highs could suggest a double top in prices. This traditionally bearish formation emerges as the result of two peaks and a resistance level that is tested but remains uncrossed. Should downward momentum accelerate and the MIB experience a candlestick close below support at 19120 that pushes it towards the 50-day moving average, a reversal may very well be in play. However, by contrast, should resistance be broken to the upside, it could imply a continuation of the medium-term upward trend.

What Binary Options Traders Should Watch For

When it comes to the Italian MIB, investors should be wary of several factors when evaluating the outlook for the index. For one, movements or decisions by the European Central Bank are likely to have an outsized impact on the MIB. Its oversized footprint thanks to asset purchases is creating significant tailwinds to push the MIB higher.Any reduction in purchases that exceeds forecasts or shortened timeline for ending purchases will likely be negative for the index.

Besides monetary policy, the major looming risk is government intransigence.Should action on structural reform and fiscal stimulus remain absent, it will likely be negative for the overall Italian economy and stocks. The next major event for Italy is GDP figures on February 14th, however, until then, should yields on Italian debt continue to rise, expect more downward pressure on stocks over the medium-term.