Turning The Corner: Italy’s Equity Markets

After two months of stalemate following what markets considered very disturbing election results, Italy has a new government, one that is considerably better for the country and the economy than many had feared. The government, headed by Enrico Letta, the new center-left prime minister, is a three-way coalition. The new economy minister is Fabrizio Saccomanni, the highly respected director general of the central bank, the Bank of Italy.

Growth Agenda
It is clear that the new government will pursue a pro-growth agenda and will be a leader of the anti-austerity movement in Europe. They have already canceled some planned tax increases which would have taken in up to 6 million euros in revenues. Moreover, the government plans to undertake a series of tax cuts. Still in recession, the last thing the Italian economy needs is tax increases. Bear in mind that the deficit situation in Italy is much better than in France, the UK, or the U.S. Nevertheless, Mr. Letta promised that Italy would abide by it’s commitment to eliminate its structural deficit. In the same statement he called for the EU to move away from policies focused on austerity and towards the promotion of growth and employment.

The bond market welcomed political developments in Italy, permitting the country to auction 3 billion euros of five-year bonds at 2.84% and 3 billion euros of 10-year bonds at 3.94%, the lowest auction yields for such bonds since October 2010. Another indication of the improvements in the market’s attitude towards Italy is the increase in Italy’s bank deposits in March. Some had feared the debacle in Cyprus would lead to stress in the banking systems of other peripheral economies.

Stocks
The Italian equity market has also performed positively. In our Commentary of March 14, Are There Investment Opportunities in Europe?, we saw the possibility of Italian equities outperforming the German, French, and Dutch markets over the next 12 months as the economy recovers. That Commentary was written at a time when the Italian ETF, iShares MSCI Italy Capped Index, EWI, had declined by almost 14% from its January-28 high and was heading lower. That call was in part value-based, with Italian equities very cheap, near multi-year lows. We also noted a number of positives for Italy, including the relatively strong position of Italian banks and the fact that the private sector carries relatively little debt. The outperformance of Italian equities developed over the course of April, with EWI up 13.07% for the month. This was almost three times the 3.57% gain in the main Germany ETF, iShares MSCI Germany, EWG. The iShares MSCI EMU Index ETF, EZU, which covers the euro-zone markets, advanced by 6.34%.

Optimism
Presumably, investors are looking ahead to a recovery in the Italian economy despite the latest economic indicators, most of which reflect an economy still mired in the recession that has persisted for eight consecutive quarters. Italian manufacturing confidence dropped in April. Italy’s unemployment rate reached 11.7% in January and was still 11.5% for March, rates not seen since 2000. On the positive side, the Italian manufacturing PMI rose in April. The new government will find its pursuit of a pro-growth agenda challenging. Today’s moves by the European Central Bank to cut the benchmark interest rate to a record low of 0.5%, and signaling that the door is open to further monetary easing will certainly help. It is hoped the Italian government will be able to make further progress in the economic reforms undertaken and proposed by the previous Monti government.

When considering an ETF that covers a national market, in addition to evaluating prospects for the economy, we also consider a number of technical and valuation factors, using the ETF Service of Ned Davis Research and the ETF Analytics Service of Index Universe. Positives for the Italian market ETF, EWI, are its high liquidity and tradability, a Ned Davis long-term (3-6 month) relative strength rating of 4 out of 5, and a Ned Davis Trend score of 5 out of 5. On the negative side, Index Universe notes some past problems with tracking its index, along with the high concentration of its holdings, with the top three sectors -- energy, utilities and financials -- making up about 75% of the portfolio. The oil company Eni S.p.A. accounts for over 20%. We would prefer greater diversification.

On balance, we think the prospects for additional outperformance are good. We are maintaining our Italy position in our International and Global Multi-Asset Class Portfolios.

This commentary was written by Bill Witherell, Cumberland’s Chief Global Economist. He joined Cumberland after years of experience at the OECD in Paris. His bio is found on Cumberland’s home page, www.cumber.com. He can be reached at Bill.Witherell@cumber.com.