The referendum called by Italian prime minister Matteo Renzi in October or November this year could have massive implications for European equities, according to Russ. “It is potentially hugely more significant for that country than Brexit will be for the UK, and by extension therefore, of critical importance to Europe and European equities,” Russ wrote.
Italy requires reform and needs a stable government capable of commanding a majority in both upper and lower houses, noted Russ. "The problem is that for this to occur, Italy must first have serious reform of its political system, an objective that could only be achieved by a stable government... and so on," he explained.
The solution to this "Catch 22" has eluded the country so far, in Russ's view. Italy has had more than 60 different governments since the end of World War II (after Italy reconstituted itself as a republic in 1946). Since each government only has lasted for a little more than a year on average, the country's political system remains largely unreformed.
Renzi aims to win the October referendum on constitutional reform, betting his political future on the attempt to give Italy a stable government. He has already launched an initiative that would streamline the number of members of the Senate from 315 to 100.
The legislation has already been passed, but did not reach majority and is now up for the Italian public to decide in the forthcoming referendum, which would give Italy the chance to pass the critical reforms.
"Italy is running out of time in which to update its economy, and as it falls further behind other major European nations, there is a risk it misdiagnoses the problem as membership of the euro", said Russ.
"That has exacerbated the situation, for sure, but it is a symptom rather than the underlying problem. Incredibly, Italian industrial production is still even now below where it was in 1990, seeing almost no recovery so far from a devastating drop of 26% in the financial crisis," he added.
What makes this referendum a hot market topic, according to Russ, rather than wishful economic thinking, is that Renzi has threatened to resign if he loses. "If that happens, the President has the option of forming yet another government, or calling early elections," Russ noted.
The fund manager noted that if the anti-euro party the 5-Star movement would win instead, it could bring with it massive disruption instead of stability, just like the EU membership referendum did in the UK.
“When one considers the carnage when the UK decided it no longer wished to be part of a customs/political union, imagine how markets would treat the prospect of a eurozone member deciding to leave," said Russ.
He also warned that an Italian banking crisis could overwhelm the country's economy, "leading to a lost referendum, a political crisis and then by extension an existential crisis for the euro."