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Trading  | May 29, 2017

Despite a promise last week by Italian Industry Minister, Carlo Calenda, that Italy would not have early elections this autumn, Italian stocks have tumbled to one month lows and the Italian bank sector is down 3% in Monday trading, its biggest one-day loss in nearly 4 months, with traders citing rising risks that the euro zone’s third largest economy could head to early elections in the autumn.

The reason for the sudden concern is that in an interview on Sunday former Prime Minister Matteo Renzi suggested that Italy’s next election should be held at the same time as Germany’s, adding this made sense “from a European perspective.” Germany will vote on Sept. 24, while Italian elections are scheduled for May 2018, but speculation is mounting that Italians could head to the polls in the autumn. Renzi, leader of the ruling center-left Democratic Party, told Italy’s newspaper Il Messaggero that his party “would not ask for early elections, but is not afraid of them either”.

After regaining the leadership of his PD party in late April, Renzi has favored early elections. He told Il Messaggero that it may be possible to reach an accord on a voting system modeled alongside Germany’s proportional model, as suggested by former center-right prime minister Silvio Berlusconi.

“In theory yes, but we must be cautious,” Renzi said. “The German system would be a step forward in overcoming the current stalemate, but it’s not a solution to all problems. Having a coalition in power is very risky.”

The possibility of a victory for the anti-establishment 5-Star Movement, which recent polls put neck and neck with PD at around 30 percent, has made Italy the biggest risk for the euro zone in the eyes of some investors.

Commenting on the market’s reaction to Renzi’s statement, LC Macro Advisers’ founder Lorenzo Codogno said that “the latest news out of Italy seems to suggest that a new electoral law is indeed in the making. The four major parties appear to converge towards the so-called German system, i.e. a purely proportional system with a 5 percent entry threshold.” Quoted by Reuters, Codogno also added that “the risk of early elections has suddenly increased to 60 percent, in my view. A hung parliament is thus the most likely outcome (95 percent probability).”

Adding to the stakes, Italy’s 5-Star Movement voted over the weekend in favour of a proportional electoral system, raising the chances of an unprecedented autumn parliamentary election according to Reuters.

On Sunday, 5-Star’s supporters overwhelmingly backed a proportional law modelled on that of Germany, in which parties must win at least 5 percent of the national vote to get into parliament. It called for a national election on Sept. 10. That means Italy’s four most popular parties, including the ruling Democratic Party (PD), have now signaled a willingness to support a voting law based on proportional representation (PR).

Italy must hold an election by May of next year; it has never had a parliamentary election later than the month of June. In addition it must present a budget with an estimated €17 billion in spending cuts or extra revenue in October, and pass it by the end of the year.

To be sure, president Sergio Mattarella, the only figure with the power to dissolve parliament, has said elections should only be held after parliament has passed a new electoral law to harmonize voting systems for the Chamber of Deputies and the Senate. For an autumn vote, he may also demand a budget agreement among the main parties, a Reuters source said.  However, recent developments may force the president to revise the schedule: “There’s a budget to pass, but if the (electoral law) agreement holds, I believe there will be an election in the autumn,” a source close to the president said on Monday. The willingness of all the major parties to vote on a new electoral law “makes an autumn vote more probable,” a government source also told Reuters, “but things will be more clear in 10 days’ time”.

An early vote would allow the ruling Democratic Party (PD) to avoid taking full responsibility for the 2018 budget, and could hand a new government a mandate to tackle the country’s chronic growth problems, shore up its struggling banking sector, and push for more help to manage the ongoing migrant crisis.

It would, however, also mean a more unstable government, with polls showing a PR system would not produce a clear winner, and post-vote alliances look unwieldy. As a result Italian stocks fell more than those in other European markets on Monday due to worries over an early vote, with the FTSE MIB sliding to nearly  one month lows.

Spooked by the Renzi comments, Italian bonds were also sold with BTP futures extending their slide in thin liquidity, and the 10y yield now higher by 8bps to 2.18% the biggest spike in 2 months.

The biggest loser, however, was the Italian bank stock sector, which slid by 3%, its biggest drop in 4 months.

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