Growing Italy risk puts equities at deepest discount in 35 years
While Italian equities (.dMIIT00000PUS) have historically been cheaper than global peers, their discount has now widened to 50%, the biggest gap since 1988, and has held at that level for a couple of months. This is twice as wide as the average gap seen over the past two decades.
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Italian stocks are trading at their deepest discount in 35 years compared to world shares as investors fret over the fiscal outlook in one of Europe's most indebted economies, although some reckon the shares are too cheap to ignore.
While Italian equities (.dMIIT00000PUS) have historically been cheaper than global peers, their discount has now widened to 50%, the biggest gap since 1988, and has held at that level for a couple of months. This is twice as wide as the average gap seen over the past two decades.
Yes, Milan's blue-chip index (.FTMIB) has rallied this year as it is geared heavily towards banking stocks that have benefited from the steepest rise in euro area interest rates on record.
TRENDING NOW
But domestically focused companies in sectors such as consumers and industrials have been hurt by an aging population, debt at over 100% of GDP and two decades of near-zero economic growth that was only briefly interrupted by a post-COVID rebound.
That has left Italian equities overall more cheaply valued than even battered UK shares (.dMIGB00000PUS), which are trading at a 33% discount to global peers.
Italy's domestic stock market "is not particularly an area I want to be exposed to," said Chris Hiorns, head of multi-asset and European equities at EdenTree, citing concern about Italy's fiscal outlook.
Recent cuts to economic growth and increases to budget deficit forecasts have revived concern about potential sovereign stress, pushing the premium investors demand to hold 10-year Italian bonds over safer Germany above 200 basis points (bps) last month .
That gap has narrowed but remains vulnerable. A test looms on Friday when Fitch reviews Italy's BBB credit rating and stable outlook.
"A change in the outlook cannot be ruled out, given lower growth, higher interest rate expenses and the deterioration in Italy's fiscal position," Barclays said in a note.
Goldman Sachs estimates that each 10 bps rise in sovereign spreads takes around 2% off Italian bank shares and 1.5% off the FTSE MIB index. It advises avoiding the blue chip index after its outperformance.
Italy's funding needs are being further complicated by its difficulties in meeting conditions set by the European Commission in return for billions of euros of post-pandemic recovery funds.
Conflict in Ukraine and in the Middle East meanwhile threaten to spark a fresh surge in energy prices and weaken growth.
The number of outstanding units in BlackRock's iShares MSCI Italy ETF has more than halved to 8.6 million from 18.9 million in October 2021. Its MSCI Europe ETF has seen the number of units fall by less than 10% over the same period.
"RIDICULOUS MULTIPLES"
While Italy's weak economic outlook and high debt suggest a significant re-rating of shares is unlikely anytime soon, investors expected some clawing back given just how deeply discounted some parts of the market are.
The FTSE Italia Star (.FTSTAR) index, tracking companies with a market cap of up to 1 billion euros ($1.07 billion), has fallen 10% so far in 2023 after last year's near 30% plunge. By comparison, the FTSE mid-cap index (.FTMC) is down 5% this year.
Smaller Italian stocks have been hit by outflows due to the end of a government-sponsored scheme to promote investment into small-sized domestic stocks, said Giuseppe Sersale, strategist and portfolio manager at Anthilia in Milan.
"Many companies are trading on ridiculous multiples. A window of value is opening up on small caps, which is worth seizing," he said.
Andrea Scauri, senior portfolio manager at asset manager Lemanik, said high visibility on earnings due to elevated rates and stronger balance sheets make Italian banks less vulnerable to debt jitters than before.
"If the spread widens, this will have a short-term impact," he said.
Scauri owns shares in smaller Italian lenders such as Banco BPM (BAMI.MI) and Monte dei Paschi (BMPS.MI), whose cheaper valuations make them more attractive than larger banks, he said.
Banco BPM shares are trading at around 0.55 times its price-to-book value and Monte dei Paschi at 0.39 times, much cheaper than UniCredit (CRDI.MI), Italy's No.2 lender by market value and trading at 0.66 times, according to LSEG Datastream.
UniCredit shares are up almost 80% this year and among the best performing euro zone banking shares.
Fidelity International portfolio manager Alberto Chiandetti, said he was chasing opportunities in battered industrials and consumer sectors in the FTSE Italia Star index.
"In many cases, valuations have already factored in the economic slowdown, while not reflecting the value and growth that many of these companies will have in the coming years," he added.
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