Specter Of Populism Plagues Europe ETFs

Last year, European stocks and the related exchange-traded funds dealt with the specter of a populist wave sweeping across the Eurozone. Election results in France and the Netherlands assuaged those concerns, but thanks to recent events in Italy, some global investors are concerned about a populist cloud hanging over European markets.

Italy is the third-largest Eurozone economy behind Germany and France, so investors are rightfully concerned about Italy possibly departing the European Union. Reflecting those concerns, the iShares MSCI Eurozone ETF EZU is down 3.1 percent over the past month.

What Happened

“After a rough few days, Italian politics are likely to settle into a state of uneasy steadiness,” said BlackRock. “An anti-establishment  government is happening under a M5S-League coalition”, this time with a finance minister less openly critical of the European Union (EU) than the prior candidate.”

EZU tracks the MSCI EMU Index and holds 256 stocks. Proving that investors' contagion fears regarding Italy are well-founded, the country is merely the fifth-largest geographic exposure in EZU at just 7.32 percent of the ETF's weight. France is more than quadruple the size of Italy in EZU.

Why It's Important

Italy could be heading toward another national election, a regular right of passage there. That could spark increased political volatility for European assets, but on the upside, most Italians favor remain part of the EU and keeping the euro.

“Yet the political situation in Italy remains a moving target, and confrontations with Brussels are likely to rise,” according to BlackRock. “Polls show a majority of Italians support staying in the euro, but that the single currency and Europe have been negative for Italy area widespread. It’s also likely the new potential government will have a confrontational attitude toward Europe and Germany, slowing momentum for further integration.”

Investors remain skittish. Last week, EZU lost nearly $777 million in assets, a total surpassed by just one other U.S.-listed ETF. That brough EZU's second-quarter outflows to $1.96 billion.

What's Next

“The looming risk, however, is likely to keep credit and sovereign spreads elevated in Italy and peripheral Europe,” said BlackRock. “It may also lead to sustained lower valuations for European equities versus global ones, particularly banks.”

EZU allocates 18 percent of its weight to the financial services sector, making that the ETF's largest sector exposure.

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