Italy Macro Report

Highlights

  • The new round of QE by the ECB is supportive for bond prices, long Italian Bonds
  • Credit is flowing again, banks and SMEs are worth a small allocation in the portfolio
  • Job market composition is not supportive for consumption, avoid retail stocks

Macro overview

Italy had one of the sluggish economic performance in the past ten years, the country is expected to continue this trend for the next years, with the growth rate reaching 0.80% in 2020 and then fading toward 0.60% by 2022. It is impressive that Italy is the only country still with GDP per capita below pre-2008 levels and forecast expects that such a level will be reached only in December 2030.

Italy GDP per capita at Constant Prices 2015, SA, USD – Via Thomson Reuters

One of the main issues with Italy is that the economy is strictly tied to exports. After 2012, Italy built a strong current account, whose is expected to reach almost 3% of GDP by the end of 2019, but in the last year export activity slowed down due to the tariffs between China and United States as global trade volume diminished considerably.

In the meanwhile, despite consumer confidence is relatively high, consumer spending grew moderately with the savings rate increasing in 2018. This may be caused by a negative wealth effects associated with decreasing asset prices in 2018 from August.

To revive the economy, the Italian Government approved a budget deficit at 2.04% with more focus on the social transfers rather than public investments; the latter are assumed to be more effective in terms of growth compared to the former, but for the moment Italy seems to pursue such a path. The budget deficit calmed markets and yields started to go down since January 2019. In addition, the new round of Quantitative Easing by the European Central Banks is likely to push yields even lower. This is a unique opportunity for the country as short-term interest rates on Italian Bonds are negative in real terms, hence in could finance new projects through emission of new bonds at a negative interest rate. What is also important is to increase the duration of Italian bonds as the structure of the debt is mainly short-term compared to other Eurozone countries.

As a result, the idea of buying Italian bonds must be taken in consideration especially the ones with longer duration as the Italian Government is committed to pursue the “European” agenda as well as the QE by the ECB is going to help yields going lower.

Credit market, banks and SMEs

As a result of the 2011 crisis, a lot of bad debts accumulated in the banking sector. As consequence, the Italian banks had to recapitalize as well as creating new capital buffer. In the past years, banks worked hard to reduce their exposure to non-performing loans, mainly via securitization, but at the same time they kept a high exposure to Italy sovereign bonds which might sound non-attractive although given the new round of QE by the ECB, they are going to have high capital gains from such a policy, driving up profits.

One of the main results of bad debts in the banking system has been the drastic reduction of credit for non-financial and quasi corporations. This was caused by the risk aversion of banks whose did not trust anymore borrowers, reducing credit by (…) billion between 2011 and 2018. As we can see in the chart, credit is still in downtrend with no sign of recovery; if the take a closer look to the year-on-year percentage change, since 2018 credit shrunk considerably although it seems that banks are starting to lend again since the beginning of 2019.

Italy lending to non-financial and quasi-corporation, EUR, Actual via Thomson Reuters

Italy Credit to Non-Financial and quasi-corporation, Year-on-Year 3 months Moving Average, via Thomson Reuters

On the other hand, credit to consumer households and household producers is ticking up, despite the latter is still in negative territory year-on-year, consumer household credit is the only one positive for the moment at 1.74% growth in July 2019.

With regards to banks, the stress tests conducted by the European Central Bank indicate that larger banks are resilient and can support tougher market conditions while small and medium sized banks remain vulnerable. As consequence, buying well capitalized banks is likely to be a winning move, like Intesa San Paolo (Ticker: ISP:MI) and UniCredit (Ticker: UGI:MI). Moreover, if credit growth persists, SMEs would benefit from new credit lines especially the one more export oriented.

Job market composition

The unemployment rate in Italy is still one of the highest in Europe at 9.9%. Even worse, youth unemployment is at 32.0%. Of particular interest is the share of the NEETs (people not in employment, nor in education), which is extremely high at 20.1%, still the largest in the EU. This obviously has a big impact on consumption which are have been subdued in the last 10 years and expectations are not in favour of an improvement.

Furthermore, the composition of employment growth is not supportive at all for private consumption. Temporary contracts are the most popular in Italy, while permanent ones are becoming less popular every year. This is another argument supportive for the long position in bonds, as there is a link between consumption and interest rate.

Composition of employment growth, Cumulative change in thousands, via ISTAT

If we add to the puzzle the problem of ageing population the outlook is not positive for consumptions. Italy population’s rate of growth fluctuated from -0.08% to 0.5% in the last ten years. Immigrants share on the whole population increased from 6.0% in 2010 to 8.0% in 2018 and seems that they are the only category whose support consumption, although they are still a small fraction of population.

Thus, it is a good strategy to avoid stocks focused only on Italy, especially retail ones or that rely heavily on private consumption. If a company looks not attractive in terms of fundamentals, we suggest also to short them in the medium term given the macro outlook.

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