Analysis

An Italian wild card

Rebecca Hampson

a city with a large body of water

The Italian bond market sell off, political instability, issues around the country's budget and the loom of Brexit makes Italy seems a pretty unattractive investment proposition. However, as Italian stocks fall to their lowest level in over a year the question over whether it signals an entry point is raised.

Italian stocks have been rocked this year as a result of political uncertainty. Following the June alliance between the anti-establishment Five Star Movement and the far-right League, Italian stocks fell nearly 3.5% in the following week - and have continued in a downward trend - while Italian government bonds witnessed a sell off.

Bonds and stocks were rocked again in recent weeks following Italy's government submitting increased spending plans to Brussels over the next three years. They unveiled a deficit target of 2.4% of GDP next year, making it nearly impossible to reduce the 130% debt pile it has (measured by debt to GDP ratio). That failure breaches the EU budget rules. It also comes as Italian Finance Minister Giovanni Tria downgraded the ministry's growth forecasts from 1.5% to 1.2% this year.

The disagreement between Italy and the European Union prompted Italian stocks to tumble and bonds to soar - and there is no clear end in sight.

Fiona Cincotta, senior market analyst at CityIndex explained: "Italy and the EU are set for a clash when the country submits its proposed budget to the European Commission with trenches being dug on both sides. Italian politicians on the right-wing and anti-establishment end of the governing coalition are repeatedly saying they have no intention to back down on plans for high spending next year, disregarding the tumbling stock markets and spiralling bond yields.

"Given that the country's debt remains at an eye-wateringly high 130% of GDP the EC is likely to reject Italy's budget proposal and open a procedure against the country's public accounts. The Commission has to make an official decision before the end of November, until then volatility will remain a key feature of Italian markets."

Market watchers are watching Italy carefully. According to an article in The FT, "Italian lenders hold €387bn of domestic sovereign debt, according to the European Central Bank, leaving them heavily exposed as the country's borrowing costs test five-year highs. Filippo Alloatti, senior credit analyst at Hermes, said the country's banks were 'super long' on Italian government debt, which accounts for between 13 and 15% of their total assets."

Italian stocks have also been falling for the last year. The FTSE MIB index, Italy's benchmark is down 10.79% year to date, -14% in the last six months and -5.4% in the last month.

Despite this, there are still some supporters and reasons to keep an eye on Italy.

CNBC reported that the analyst team at Citi predicted a few weeks ago that Italian markets will finish the year up.

Italian stock weakness was previously seen in 2011, 2014 and 2016 (although the latter was largely driven by the Brexit vote). Citi noted that the periods of weakness in 2011 and 2014, commenting in a research note: "We see it increasingly likely that history could repeat itself (in the fourth quarter of 2018)."

Citi's analysts said they prefer Italian companies generating most of their revenues outside of the country - given the slow GDP rate. It named Prysmian, Fineco, Moncler and Ferrari as stocks worth looking at.

Italy has three companies in the top twenty for revenues in Europe. According to WorldAtlas, they are the Eni Company, which ranks as Europe's ninth largest company with $153,676 million in revenues. Second is Fiat company which has its headquarters in Italy, and its revenues were $116,000 million to rank 19th in Europe. Thirdly, Exor Company is an investment company headquartered in Italy - its revenues were $117,297 million in 2014.

All are global names.

The graph below shows their performance in the last three years. ENI in orange, Fiat in black and Exor in purple.

chart, line chart, histogram

Source: Bloomberg

Another encouraging sign is that the FTSE MIB is also largely in line with the European stock benchmark. Below is a graph showing the EuroSTOXX 50 in black and the FTSE MIB in orange.

chart, line chart

Source: Bloomberg

Italian stocks are now at their lowest (and cheapest) level in over a year, despite the FTSE MIB hitting its highest level in May for over five years. The drop off over the last few months comes after a year and a half rally in Italian stocks that saw the FTSE MIB gain more than 40%, suggesting that what goes down comes back up.

It's fair to say that there may still be further to drop for Italian stocks, but it's worth keeping an eye on when you look at the historical patterns (although they can't guarantee future performance).

Using an ETF to get exposure gives investors the option of holding it long term and there are six ETFs, although other ETPs are available, to choose from and are listed on the London Stock Exchange. The biggest of these is Lyxor's MIBX, which has €476m in assets and was launched in 2014. However, it's not the cheapest at 0.35%, instead Amundi's Italy ETF is with a TER of 0.25%.

The table below shows some of the ETFs and ETPs tracking Italian stocks on the LSE:

MIBX

CMB1

IMIB

CMIB

ITBL

CI1

ETFTER3month RTNINDEXLyxor FTSE MIB UCITS ETF0.35%-10.90%FTSE MIB Net Total Return IndexiShares FTSE MIB UCITS ETF EUR Acc (GBP)0.33%-10.92%FTSE MIB IndexiShares FTSE MIB UCITS ETF EUR Dist (GBP)0.33%-10.92%FTSE MIB IndexiShares FTSE MIB UCITS ETF EUR Acc (EUR)0.33%-9.90%FTSE MIB IndexBOOST FTSE MIB BANKS ETP0.35%-14.52%FTSE MIB Banks 15% Capped Net Tax IndexAmundi ETF MSCI Italy UCITS ETF0.25%-10.47MSCI ITALY index TRN

You'll see that four of the ETFs track the FTSE MIB index. This index comprises 40 large and mid-cap Italian stocks so it's pretty concentrated. The Amundi ETF in the list tracks the MSCI Italy index which is fairly similar to the FTSE MIB index except that it has fewer stocks (24). The Boost ETF is even more concentrated because it's made up solely of bank stocks. The benchmark index for this ETF comprises all the banks in the FTSE MIB index with a 15% cap. In other words, no one bank can comprise more than 15% of the index.

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