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European issues were largely on the backburner to start the year, as investors focused in on solid economic data from around the world. The latest news out of Italy, though, may throw a wrench into this bullish trend and reignite European fears once more.

This is largely due to a major election for the country’s lower House and upper House (Senate), the results of which are not as clear cut as analysts once hoped. Instead of the left-center coalition, Berlusconi looks to (possibly) come in second in the lower House and possibly win the Senate.

Since Berlusconi has declared that his aim is to win enough power in the Senate to paralyze a center-left administration, we could see the reintroduction of extreme gridlock to the troubled nation. This is a serious issue given that Italy has a massive debt load and one of the major economies in Europe, a combination that could spook markets if bond yields rise (read Is The Italy ETF Doomed from a Technical Look?).

This is arguably already starting to happen as many stocks sold off after the Italian election results became cloudier and more gridlock appears to be on the horizon. Some are now fearing calls of a second election, a situation which could send markets into a tailspin in short-order, as it would definitely call into question the ability of Italy to continue on its current bailout-friendly course.

ETF Impact

The impact on the ETF world of this election has been pretty severe. Most European markets closed before more up-to-date election results were known, so many markets in the region only sold off a little during their trading hours.

However, immediately following their closure for the day, Berlusconi’s party surged and the once straight-forward results became muddled, causing many European-focused stocks to plummet. This was especially the case in the European ETF sphere as these became the go-to vehicles to play the important election, with catastrophic results across the board (see More Trouble Ahead for Italy and Spain ETFs?).

The main ETF in focus the iShares MSCI Italy Capped Index ETF (EWI - ETF report) plunged by about 5.75% on the day, on volume that was roughly three times normal. It should be noted that most of the losses came after 1pm eastern, and that a sizable chunk of the volume was in that period as well.

Beyond Italy, other PIIGS ETFs, such as those tracking Spain (EWP - ETF report) or Ireland (EIRL - ETF report) also sank heavily on the day, with Ireland’s ETF losing over 3% and Spain’s plunging by over 5.5%.  So clearly there were some broad worries over the European market thanks to this Italian election (read ETFs for 3 of the Cheapest Markets in the World).

Yet the pain didn’t stop in the weak European country ETFs by any stretch, as some for the major economies also saw their ETFs plunge on the day as well. France (EWQ - ETF report) lost about 4%, Austria (EWO) tumbled by about 4%, and even Germany (EWG - ETF report) saw losses of nearly 2% on the day.

Bottom Line

Although many U.S. investors take an American-centric approach to their investing, foreign events can and do have a huge impact on stocks across the world. U.S. stocks were down over 1.5% thanks to the Italian woes—along some sequester fears—so it is clear that in this age of globalization any good or bad news can roil the global markets (see Three European ETFs with Incredible 2012 Gains).

Given how intense the sell-off was thanks to the Italian election results, this could be a new leg of the crisis in Europe. This could be especially true if there is a mixed government in Italy or if more elections will be required.

In either case, more uncertainty will be the result, and heavier losses could follow. This suggests that investors, no matter what side of the Atlantic they are on, need to play close attention to Europe, and the trading patterns in many European ETFs for clues on how this crisis will play out.

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Follow @Eric Dutram on Twitter

Author is long EWG.

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