Fears of a Brexit-like flight from the euro — Italian-style — have global financial markets in turmoil this week, and the ramifications could be significant not just for Italy, but for markets in Europe and the U.S.
Italy — the third-largest European Union economy — is entrenched in a political struggle between populists and EU backers that has spilled over into global markets. On May 29, the Dow Jones industrial average fell by 1.6 percent, and European market indexes slid by 1 percent (Italy’s FTSE MIB declined by 2.7 percent over the same period.)
In addition, the euro slid by 0.7 percent, to $1.1540, and investors abandoned Italy bonds in favor of U.S. Treasurys and German bonds, as the two-year Italian bond yield fell by 2.7 percent, compared to 0.48 percent the previous trading session. That’s the biggest one-day rise in Italian bonds in 26 years.
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The bond crisis in Italy is taking its toll on European and U.S. banking stocks, as major financial institutions find themselves more exposed to rising Italian government debt. Italy’s debt now stands at 130 percent of its total economic input.
A populist uprising in play. With Italy in crisis, how should investors view the country as an investment landing spot, and how and when will Europe rebound from its latest EU-related financial free-for-all?
A glimpse at the current political landscape in Italy offers some helpful clues.
“The likely outcome of the crisis is a general election in October with an even bigger majority for the populists,” says Luca Paolini, chief strategist at Pictet Asset Management. “This means that in the coming weeks, the polls could unsettle markets even more and investors may start to see the election as a de-facto referendum on euro membership.”
It’s not that either political party wants a clean break from the EU, Paolini says. They just want a bigger seat at the table.
“Both the EU-supportive League and the populist Five Stars (the two dominant Italian political parties) have made it clear that they want Italy to stay in the euro,” he says. “They are looking for more fiscal flexibility from the EU, which is practically setting a deficit level Italy has to meet.”
The impact on euro-area growth and financial markets depends on the severity of the crisis.
“Italy is almost 10 times bigger than Greece and accounts for 15 percent of the euro-area GDP and 23 percent of its public debt,” Paolini says. “However, Italy’s economic situation has improved significantly in the last years: GDP growth is now well above 1 percent and structural reforms, like the Jobs Act and pension reform, have already been implemented.”
Paolini adds, “all in all, the current recovery is real and the country is in a far better position than it was during the 2011-12 euro debt crisis.”
Opportunity for investors? Market insiders say that despite Italy being on shaky ground politically, there are still plenty of opportunities for investors.
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“The Italian economy has been improving significantly in the past couple of years,” says Umberto Malesci, chief executive officer of Fluidmesh Networks, a technology company headquartered in Brooklyn but with half of its operations — and its entire product team – in Italy. “The country is coming out of a 10-year recession that started in 2008. The current political crisis is not helping but the real economy trajectory won’t be impacted much in the long term.”
Malesci says it’s a good time to get into the Italian stock market, but you have to know where to pick your spots.
“The domestic market is still weak, so the best opportunities for investors are with Italian companies that are exporting their products outside of Italy,” he says.
Italy has solid engineering schools and engineering talent but engineers are paid a fraction of what they are paid in other countries in Western Europe or in the U.S., he adds.
“Consequently, this provides a competitive advantage to companies with research and development based in Italy, but sales mostly outside of Italy,” Malesci says. “Valuation and multiples are lower compared to the U.S., but engineering talent is world-class,” he says.
Aim for Milano. Investors who are looking for high-growth, small-cap public companies should focus on the AIM Milano (the small-cap market on the Milan Stock Exchange), Malesci says.
“AIM-listed companies in Milan experienced a pretty exciting growth in value in 2017,” Malesci says. “Many mid-size private companies are considering going public on the AIM Milano due to the recent successes. Some of the recent success of the AIM Milano market has been driven by new tax laws that provide tax breaks to Italian investors who decide to invest in AIM-listed companies (and other Italian equities) and hold the investment for five years.”
The investment path forward in Italy largely depends on what happens politically. Market experts say events on the ground in coming weeks likely won’t be comforting to Italy-minded investors.
“Italy achieved a superficially positive political outcome when its figurehead president decided not to allow the country’s two populist parties to form a government that might have threatened Italy’s relations with the rest of Europe,” says Eric Lascelles, chief economist for RBC Global Asset Management. “While we don’t ultimately expect Italy to exit the eurozone — in fact, Italian attitudes toward the euro have improved over the past five years and are net positive — another election is now fairly likely, and voters seem distinctly tempted to vote in the same populist parties, only with more support next time.”
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If this happens, Lascelles adds, “the Five Star Movement could find itself in a majority position after another election and thus able to wreak even more havoc.”
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Italy Crisis Worries U.S., Global Investors originally appeared on usnews.com
