Italy is surprisingly solvent – and that’s just one reason to buy

I’ve been banging a drum for Italian stocks for a while – since last summer in fact, when the FTSE MIB index was down at around the 13,000 level.

Like most markets, the MIB has seen a strong rebound since then. The election results, of course, put a dent in its progress, knocking it back from nearly 18,000 down to just above 15,000.

But despite the chaos, I think this is a buying opportunity. And I’m not the only one…

Italy’s debt situation is potentially better than Britain’s

I was interested to read a piece from Albert Edwards at Société Générale arguing the case for investing in Italy yesterday. For those who don’t already know, Edwards is probably one of the most bearish commentators around. So when he says “buy”, it’s worth taking note.

Edwards isn’t at all upbeat on the eurozone. Like us, he finds it hard to believe that the euro can be sustained in the long run, due to the basic impracticality of having such different economies all bound together under the one central bank.

Nor is he particularly upbeat about Italy’s economic outlook. From a structural point of view, the country has huge problems. Among developed nations, Italy has fewer graduates (in percentage terms) than any country other than Portugal. The World Bank reckons it’s harder to do business in Italy than it is in Romania.

However, there’s one key area where Italy is in a better position than any of the other ‘peripheral’ countries. And that’s on debt.

Italy has a horrible level of official national debt (the total debt pile). It clocks in at around 127% of GDP. However, its annual overspend – the deficit – is remarkably low.

For 2012, it’s expected to come in at around 2.9%, below the 3% everyone in the eurozone is meant to stick to. That 2.9% compares to 4.6% for France, 10.2% for Spain, 6.3% for the UK, and 8.5% for the US.

In other words, while Italy’s existing debt pile is huge, its spending is actually pretty much under control. In fact, the country runs a ‘primary surplus’ of 2.5%. What that means is that if it didn’t have to pay the interest bills on its existing debt pile, it would actually be making more each year in taxes than it spends on public services.

The other ‘troubled’ countries still need “massive fiscal retrenchment” in order to reduce their deficits below 3%, to meet the demands of ‘the Troika’ (the European Commission, European Central Bank and the International Monetary Fund). But, as Edwards puts it, “the heavy lifting has been done in Italy.”

Another piece from Fulcrum Research tries to ‘stress test’ Italy’s finances. They take three, ever-worsening scenarios. First, they look at what would happen if Mario Monti’s reforms were undone. Then they throw in a worse-than-expected recession, with the economy shrinking by 2% in 2013, and 0.5% in 2014. Lastly, they chuck in a panic in the bond market, which would drive interest rates higher.

“Remarkably, even after the introduction of these three negative shocks, the debt-to-GDP ratio would peak in 2015 and still be in a downward trajectory by the end of the decade, although admittedly just barely so.”

To put that into perspective, for all the talk of austerity, Britain’s debt-to-GDP ratio isn’t expected to peak until 2016 (according to credit rating agency Moody’s). And that’s being relatively optimistic about it.

In other words, Italy is in a sustainable fiscal position, believe it or not. And that means that it doesn’t need to do a load more austerity to keep its paymasters in the eurozone happy. What Italy really needs (as does Britain, though in different ways) is reform.

Reform and austerity are “the opposite of each other”, notes Edwards. Proper, structural reform, costs money. “If you want to open your labour market to a hire-and-fire rule, you will need policies to deal with those who are laid off. These costs may outweigh the financial benefits of reforms in the short term, but the reforms may still pay off in the long run.”

Of course, that’s not to say that we’ll get any useful reforms. Given the current political mess, it’s hard to know exactly what will come out of all this. But if Italy’s debt position is actually sustainable, then there’s no need for the ‘Troika’ to get bolshy with Italy. And equally, that means there’s no reason for Italians to throw in the towel on the euro (yet), which is arguably the biggest short-term risk.

How to buy Italy

So how do you invest? At current levels, I wouldn’t touch Italian government debt (believe it or not, there is an exchange-traded fund you can buy to do this). There could easily be a spike from here if more election jitters arrive, so it just doesn’t look cheap enough.

But stocks on the other hand, do look cheap. As Edwards puts it, “Italy is much cheaper than most countries in a cheap region.” On a price/earnings basis, price-to-cash-flow basis, price-to-book value basis, and dividend yield basis, Italy is far, far cheaper than its long run (since 1985) average.

Yes, “the situation in the eurozone is indeed toxic and it will get worse. That is the opportunity. Buy Italy.” I’d use the iShares FTSE MIB (LSE: IMIB) exchange-traded fund.

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  • Peter

    “the situation in the eurozone is indeed toxic and it will get worse. “

    I think the situation looks toxic everywhere.

    ” due to the basic impracticality of having such different economies all bound together under the one central bank.”

    Ever closer union worked for the United States and will work at regional level. The European will make it work then Asia & North America will copy. The world is moving to currency blocks the IMS as it is now will be reformed.

    There will be much better opportunities to buy stocks in the medium term.

  • Peter Kellow


    The USA is a federation. Yes, the euro could work if you could make the EU into a federation which is what its primary movers want

    Only problem. That will never happen. The voters won’t buy it. Currency unions are finished with the example of the euro

  • Changing Man

    You reveal some very positive and surprising factors for the relative strength of the Italian economy. However the potential for politicians to screw it up remains. If you were considering investing in a fund ( in this case Italy plc) which had no effective management, comprised of a comedian and a disgraced ex PM facing criminal charges, would you still invest? Even as a speculative punt, the current MIB valuation is too rich with risk-adjustment for my wallet!

  • Mr Grumpy

    In business I was always taught that growth is desirable but you cannot control or guarantee it. What you can control is expenditure. How long must we listen to politicians telling us that growth is the answer when what they need to do is cut costs ie government expenditure until we have a balance between cost and revenue. Ideally they would continue cutting cost so that the ridiculously high level of taxes in this country could be reduced – and that might just stimulate some growth. They are putting the cart (growth) before the horse (balancing the books) whilst the Italians have at least got a situation where their overspend is less than half ours. Wishful thinking will not solve this problem only hard nosed fiscal rectitude – and there is no evidence of that happening here.

  • Poutine

    I do agree. FTSE MIB is a cheap and good market.

    Not only Italy has a zero structural deficit but also a powerful industry (stronger than the one of France or Britain).

    You have some wonderful shares such as Fiat industrial, Finmeccanica, Luxxotican Delonghi and so on.

    You can also leverage your ETF

  • Daniel

    Do you have any of the ratios that are mentioned at the bottom of the article? They are obviously the reason why FTSEMIB would be considered cheap or rich. According to Bloomberg it has the lowest dividend yield of the European major indices @ 3.3%.

    Cant see a strong case in your article to buy Italian equities given the political uncertainty. We could have new elections very soon and an extreme sell off if they still cant form govt.

    Even with that still might be worth investing if there is an extreme discount, but would like more detail there.

  • Daniel


    – The inconclusive results of the Italian parliamentary elections on 24-25 February make it unlikely that a stable new government can be formed in the next few weeks. The increased political uncertainty and non-conducive backdrop for further structural reform measures constitute a further adverse shock to the real economy amidst the deep recession.

    That priced in?

  • Boris MacDonut

    Not sure why it is a suprise. I have banged on about this for three years now. Italy has very little personal debt, huge ghold reserves, masses of loot in Switzerland, little overseas debt and no deficit. It is one of only 3 EU nations to have repaid any Government debt these past 5 years and it still makes and sells stuff the world wants. …….Spain on the other hand is fast becoming Europes next failed state.

  • MB

    Italian primary surplus? Are the Italians better at collecting taxes than us? Better at controlling costs? Weak unions? Strong politicians able to push through unpopular measures!! How did they get it so right and us so wrong. Maybe we should have gone for an Italian as Governor of the Bank of England. It all looks a bit Greek to me.