With more bailouts than a termite-ravaged dinghy and one in four workers unemployed, Greece has inspired the ire of many eurozone officials whose sentiment is summed up nicely by University of Pittsburgh professor Jay Sukits: “I always though the best thing to do about Greece would be to get a big saw, cut it off and let it float out into the Aegean Sea.”
But Sukits, a clinical assistant professor of business administration finance at the Katz Graduate School of Business, warns: “You can’t do that with Italy.” There’s no chainsaw massive enough because compared to Greece, Italy has a much, much bigger economy — the eighth largest in the world. And it’s skidding down a dark path that could make Greece’s financial woes look like a picnic in the Parthenon.
Smart-yet-cautious investors are already turning their attentions toward Italy, due to its “too big to fail” status — emphasis on “fail.” The statistics tell a grim story: Italy’s perilous public debt — 132 percent of its GDP — is second in Europe only to Greece’s dizzying tally of 177 percent. “That’s just outlandish,” Sukits says of Italy’s debt situation.
Meanwhile, unemployment has doubled since early 2008 to 12.7 percent. And if the ground under Italy’s economy collapses, one big question is whether it will swallow up its investment properties that populate the New York Stock Exchange and the Nasdaq.
While eyewear giant Luxottica Group (ticker: LUX) and Fiat Chrysler Automobiles (FCAU) are global companies, “they will remain highly correlated to the Italian equity market,” says Tom Manning, CEO of F.L.Putnam Investment Management Co. “Should Italy’s economy slump in 2016, we would expect these companies to move directionally with the market.”
But what might save businesses headquartered in Italy — including Ferrari (RACE), an October spinoff of Fiat Chrysler — comes back to worldwide presence. “If a company does 70 to 80 percent of its business outside Italy, it should be OK,” Sukits says. “And if the Italian economy collapses, it could even become a target for takeover from an outside company: It might look undervalued if it produced a strong product with strong international demand.”
If you haven’t heard a peep about Italy’s woes, you’re far from alone. The nation of about 60 million rarely makes headlines in the U.S., save for the tourism blogs. But in London, for example, Italy’s state of financial affairs garnered coverage in The Telegraph and The Guardian.
Moody’s currently rates Italy’s bonds at “Baa2 stable,” just two levels above junk — and in December called the nation’s 2016 draft budget a “credit negative” due to proposed deficits higher than those forecast in April.
“Despite this, we believe Italian bonds offer compelling value,” says Jack McIntyre, portfolio manager and senior research analyst at Brandywine Global in Philadelphia. Bonds in Italy, along with the troubled nations of Portugal and Spain, “are not trading based on their individual credit ratings, but on the European Central Bank’s creditworthiness because the ECB is the ‘buyer of last resort.’ This keeps us long on Italian bonds, on the 30-year part of the curve.”
Meanwhile, Italian officials continue to send out strong signals that they grasp the scale of their predicament and are working on solutions. In June, Antonio Villafranca of the Italian Institute for International Political Studies told The Guardian that while his nation’s public debt was “huge,” it was also “sustainable” because Italy’s cost to borrow money is close to that of Germany, the eurozone’s strongest economy.
“To the degree that an Italian prime minister can truly influence structural reforms in Italy, we think Prime Minister Matteo Renzi gets it,” McIntyre says. “He will try and make Italy more competitive, with efforts including labor market and education reforms.”
The latter especially needs close attention, for while investment and education don’t always seem to mix, the latter impacts any effort to create a thriving workforce. Consider Sicily, where youth unemployment approaches or tops 40 percent.
“Italy is in desperate need of structural reform,” Manning says. “We are largely in agreement with Renzi’s proposed reforms and believe they would create a more stable political system.” Still, he maintains that for this year at least, eminent collapse remains a remote prospect.
“We don’t think investors in U.S. securities should concern themselves too much at this point with issues that are largely Italian in nature,” he says. “However, we will certainly watch events in Italy closely during the year as things can change quickly.” The yellow lights include Renzi’s proposed reforms: “His ability to push them through a referendum later in the year is far from a given.”
If referendums fall short and the economy falls down, at least a precedent exists for relieving financial panic. All a cautious investor need do is look back to Greece’s turmoil, says Michael J. Driscoll, clinical professor and senior executive in residence at Adelphi University’s Robert B. Willumstad School of Business.
“Right or wrong, the actions of the troika of the World Bank, International Monetary Fund and European Central Bank seem to have allayed investor concerns over what the implications were for a member of the European Union defaulting on its debt obligations,” Driscoll says. “For the larger economies of Europe, Greece acted as a canary in the coal mine.”
But in the meantime, investors can’t yet count on Italy and its citizens pulling their weight should outside forces intervene. “There are only two ways for a country like Italy to get out of this situation — you institute huge amounts of austerity while you pay off your debt, and you have to stimulate growth,” Sukits says.
As for the latter, he adds: “The government in Italy is not going to just start making wine and selling it internationally — although if governments were to make wine, it would probably taste terrible.”
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Why Investors Should Be Wary of Italy originally appeared on usnews.com
