Equities took a big hit yesterday, on news that the Italian election has resulted in no party having a majority in the Senate, something that is required in order to form a functioning government. I have made a mistake here. In January I shorted equities but was stopped out as a wave of Japanese liquidity pushed global markets upward. Now that that wave has come to an end — as shown by the behaviour of USD/JPY — I am looking for opportunities to get short again. There was such an yesterday morning, as the market bounced, but I did not take it.

My January trade was not a mistake, although it was a loser. I followed my process, but a new and unexpected factor caused a loss. My lack of a trade yesterday was a mistake. I was looking for a chance to get in, and didn’t take it. I made the classic mistake of giving myself more time when there was no reason to believe that more time would reveal anything new. The fact that the chance was only around for a few hours is really no excuse. I should have been ready. I did not respond to the January trade with a process change, because it was merely a loser, not a mistake. I will respond to this latest mistake with a process change.

I am still looking for a chance to get short of equities. Markets often give second chances.

The Italian results, according to Bloomberg, were as follows:

Chamber of Deputies:
Bersani 29.54%
Berlusconi 29.18%
Grillo 25.55%
Monti 10.6%

Senate:
Bersani 31.63%
Berlusconi 30.72%
Grillo 23.79%

Bersani, as head of the largest grouping, will automatically have a majority in the Chamber of Deputies, but in the Senate, where seat bonuses are awarded on a regional basis, nobody will have a majority.

The market has reacted to the appearance of “instability”. Markets don’t get politics. Let’s try to think through some implications of the election result.

First, what are the implications for one’s assessment of the state of political opinion in Italy? I am not sure that it is straightforward to take the result as a rejection of austerity. Certainly Mr. Monti was not popular, but he was at the head of a coalition of existing parties with existing agendas. Mr. Berlusconi made a lot of headway in the polls by opposing austerity, but Mr. Grillo and his Five Star Movement, although also anti-austerity, have a wider anti-establishment agenda. Italian politics has long been either unstable or dominated by the ridiculous Mr. Berlusconi, and voters’ frustration with that situation may have been as much of a reason for the success of Mr. Grillo as his opposition to austerity.

Second, what are the implications for the shape of the next Italian government? There is already talk of a new election. It is unlikely, but possible, that Mr. Berlusconi could form a coalition with Mr. Bersani — he is, after all, a strong supporter of his own interests. I do not know why the possibility of a minority government (i.e. without a Senate majority) is being written off — I believe Italy often had minority governments in some sense prior to the 1980’s, although they were generally unstable. I do not have a basis for predicting what is going to happen, but it seems to me that there is a range of possibilities.

Underlying all of this is the observation that politicians are incentivised to cooperate with other European leaders once they are in power. An intransigence could mean rising bond yields and no possibility of bailouts. Therefore, while there may be some short-term noise (I would definitely be cautious of being long equities at this point), I do not see strong evidence that it is likely that Italy will revolt against the European consensus just yet.

Just a final note: sequester watch. The focus on this issue is still growing: http://bit.ly/XWRqAu.

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