The end of the euro crisis has turned austerity Europe into the hottest equity markets. Greek stocks were the second best-performing market in 2013, with a 44 per cent return. Spanish stocks gained 24 per cent between the announcement of US tapering in May to the end of the year, whereas the FTSE All-Share delivered a 4.6 per cent total return.
Until lately, Italy has been left out of the re-rating of Europe. Italian stocks have lagged the rebounding Eurostoxx by more than 40 per cent over the past five years. While Italy has plenty of economic and political woes, it is no less worthy of a re-rating than many of its eurozone peers.
Italy left behind
Admittedly, Italy has not suffered a sharp fall in wages, unlike Ireland and Spain. So, while those nations are now enjoying a boost thanks their greater competitiveness, Italian unit labour costs are rising and growth is subdued. Real GDP is likely to grow by around 0.5 per cent this year, one of the slowest rates in the developed world.
However, Italy emerged from recession over last summer and exports are now rising. The constraints imposed by political stalemate and a history of high interest rates means that the Italian budgetary position is not as gloomy as you might think. Italy runs a significant primary surplus - the budget excluding interest payments - of 2.2 per cent of GDP, as well as having a defined-contribution public pension system. The European Commission predicts a government deficit of 2.6 per cent of GDP this year, half that of the UK’s.
Critically, the worst of Europe’s financial crisis is over. Italian government borrowing costs have fallen to their lowest since 2005, with 10-year bonds yielding 3.4 per cent. Given inflation of 0.5 per cent, this is still one of the highest real rates in the developed world - and further declines in yields are likely. And since Italy has the third-largest government debt in the world - set to peak at 135 per cent of GDP this year - lower borrowing costs would be a great benefit. Italian banks own a lot of government bonds and have made outsized profits from their holdings. In equities, financials make up some 38 per cent of the market and should keep benefiting from falling bond yields.
Cheaper borrowing
We at Nutmeg significantly increased our client portfolios’ holdings in Italian stocks. last November. We reckon the gradual turnaround in the economy and the re-appraisal of European stocks makes Italy too cheap an opportunity to miss. Italy trades on a forward price-to-book ratio of 0.95, against 1.6 for Germany, 1.3 for France and 2.4 for the US. Few ‘cheap’ emerging markets are better value, including those with high political risk. Even Egypt and Turkey are more expensive than Italy, for example. Italy has posted one of the best stock market performances of 2014 so far - returning 2.4 per cent in January and 5.3 per cent in February. There is further potential for Italian stocks to play catch-up in 2014.
Shaun Port is Chief Investment Officer of Nutmeg, the online discretionary investment management company.
