Neil Dwane, CIO Europe at Allianz Global Investors, says that the protest vote in the pending Italian elections - led by comedian Beppe Grillo - may leave greater uncertainty for investors.
Neil Dwane, CIO Europe at Allianz Global Investors, says that the protest vote in the pending Italian elections – led by comedian Beppe Grillo – may leave greater uncertainty for investors.
Whilst the election may provide many of the headlines, what will be crucial to assess in Q2 2013 is the direction of Policy. Monti’s austerity is now in place and being enforced and its benefits are only now beginning to be perceived. Nevertheless, any wavering or relaxation might become a concern, especially as Italy has only to make some small budget savings to reach a balance where Sovereign debt is not growing – which is unlike the challenges of Spain, France and the UK where budget deficits are closer to 10% of Gross Domestic Product (GDP).
Challenges to the economy
However this gap may worsen as already Italian GDP is lowered for 2013 to a recessionary -1.3% , with sales falling 6.7% in December and industrial orders -5.4%. This lack of economic momentum could place more pressure on politicians to deliver more austerity, all things being equal.
Part of Monti’s unpopularity could be due to the fact that he started to restructure the Italian economy through reform of product and labour markets and pushing back protection for workers and regulation in the economy. Whilst this was a good first step, he did not address the wider and arguably more important issues which centre around Italy’s attractiveness to corporate investors. Without a further rounding out of all issues, Italy may remain consigned to a future which looks very much like the last 20 years: low growth, low economic momentum and susceptible to regional and global pressures, and burdened by high debts at the sovereign level.
Low productivity is one of the key factors, highlighted by a new AllianzGI report, resulting in poor competitiveness, not only compared to Germany, but also to the rest of the peripheral EU countries. Constant wage hikes have led nominal unit labour costs to rise by more than 30 % since 2000. In contrast, this figure increased in Germany by slightly less than 10% during the same period.
The Italian banking sector is less exposed to the global ‘casino’ markets but may be very much key to the Italian economy. They find themselves possibly with a strong, conservatively financed private sector, without much evidence of property bubbles but with little demand for credit. This has resulted in the domestic banks being over-exposed to the Italian Sovereign bond markets. This clearly can be good and bad.
With the implementation of the LTROs and the ECB’s “all it takes” pledge and events last summer, Italian banks, their funding and their shares have all improved but, with little real end demand. They have in recent months increased their exposures to the sovereign now that Draghi has their backs; whether this is really positive for them is a matter of time, since the doom-loop of banks-sovereigns-banks is thus being deepened in most eurozone economies, including France, Spain and Italy. Thus investors should expect at some point in 2013-14 that markets will likely test this new-found policy from the ECB rather than just its words, and if it is found wanting, then significant stress will probably return as through the last three years.
On a standalone market basis, Italy currently looks very cheap at 8x when measured on a cyclically adjusted price earnings basis (CAPE); compare that with the USA on 22x, Japan on 16x and MSCI Europe on 14x. At AllianzGI’s recent Investment Forum it was concluded that most European markets are cheap when compared to many developed and developing markets, although this perhaps is not surprising in light of the extent of the EU crisis.
On a very long-term basis, Italy is cheap but shorter term prospects seem to be more challenging as the economy is below stall speed and would need the longer term restructurings to offer hope of a reversion to mean levels. We think many investors still confuse the prospects of Italian companies with the problems of Italy; but this is a mistake as nearly 50% of profits derive from outside Italy. In fact we think a number of Italian companies can be identified that have a truly global footprint and low dependence on Italy’s GDP growth.
Italy on its own and within the Eurozone markets looks attractive and should continue to benefit from the slow integration processes which typify the development towards a ‘United States of Europe’ with fiscal consolidation, banking unions and other harmonisations in time. However shorter term, Italy has the political and policy capacity to hold back its own development and restructuring progress and it could also be held hostage to a change in the current “risk-on” attitudes of banks and international investors. Within the equity market, there are attractive well-run opportunities which we are focused on adding to our portfolios when the stresses resurface.