With 63 governments in 70 years, Italy is known for political turmoil. This probably explains why U.S. investors appeared to be unfazed Monday by Italian Prime Minister Matteo Renzi's decision to step down. The Dow Jones Industrial Average notched a new record closing high. Investors focused on growth opportunities and shrugged off the bad news.
This indifference might turn out to be misplaced. Political instability in the eurozone's third-largest economy doesn't bode well for the future of either the euro or for U.S. companies with significant European exposure.
After the Brexit outcome and Donald Trump's victory, financial markets were a third time lucky. Polls got it right ahead of Italy's referendum, so traders were prepared. Italy's problems, however, are far from over. The referendum was on proposed changes to the nation's constitution that would have made the legislative process more efficient. It was opposed by right-wing and populist parties, including those that want to discard the euro and are antiglobalization. A former comedian and now full-time politician could very well decide the next prime minister. The euro witnessed an immediate slump following Renzi's resignation.
For the moment though, everybody is happy that the results were as expected. Certain blue-chip investments soared.
Shares of Ferrari (RACE - Get Report) touched a record high in Milan trading, spurred by buying in companies that have high exports to countries outside Europe. Fiat Chrysler (FCAU - Get Report) , which generates most of its profits in North America, saw its stock rise, too. For many Italian investors, the key strategy would be to invest in companies that sell to the U.S. market, since a strong dollar is going to make it cheaper for Americans to buy Italian products.
But a weaker euro is not good for American companies that export a lot of products to the eurozone, because it will make those products more expensive.
Coca-Cola European Partners (CCE) , which is the world's largest independent Coca-Cola bottler and has 100% exposure to Europe, has seen its shares fall 19% year to date. The company is already expected to post flattish growth in 2017 sales, after a 12%-plus drop this year.
While an exit may take considerable time, it will be important to monitor companies that are significantly exposed to the European market. According to Bloomberg Intelligence, Abercrombie & Fitch (ANF - Get Report) generates 27% of sales from Europe. According to this article by Michelle Jones of ValueWalk, Priceline Group (PCLN) has exposure to the euro on about 71% of its revenue, although it is naturally hedged against changes in the value of the common currency through its Booking.com subsidiary. Owens-Illinois (OI - Get Report) derived more than 40% of its revenue from the continent as of late 2015. Companies like Mondelez (MDLZ - Get Report) , McDonald (MCD - Get Report) , and 21st Century Fox (FOXA) got 30% or more from the European region as of late 2015. (Obviously, those percentages may include U.K. revenue, which will eventually not be included in eurozone totals.) Any weakness in the euro, which fell to a 20-month low after Italy's referendum, can affect sales in the October-December quarter.
While Italy's verdict may not present a true picture of the euro's problems yet, smart investors should hedge their exposure to the currency.
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