By Matthew Lynn
A burnt-out economy. A currency that doesn’t work. Constant political turmoil, mass unemployment, deepening levels of poverty, and a bankrupt banking system.
It has not been very hard over the last decade to make the case that Italy is a basket case, and one that investors should steer well clear of. With the possible exception of Greece, there has been no market that investors have kept so far away from.
But hold on. Even the deadest economy can sometimes see a cyclical bounce-back — and just occasionally that can turn into something more durable. Over the last few weeks, there have been encouraging signs that the Italy may finally be about to see some growth.
If the eurozone really is recovering, then Italy should be one of the major beneficiaries of that. As the cheapest major market, it should be the one that has the greatest potential for gains over the next year. It is already rising more strongly than France or Germany, and that run could carry on for a lot longer yet.
Of all the damning statistics on the performance of Europe’s single currency, few were more telling than that Italian gross domestic product was no larger now than when it joined the euro (XTUP:EURUSD) . For close on two decades, it had not expanded at all. You could be hitting 40 and have spent your entire career in a zero-growth world, with probably a zero rise in real wages as well — that is, if you were lucky enough to have a job.
In the last month there have been some signs that is about to change.
In May, industrial production grew by 0.7%, ahead of expectations of a 0.5% rise. On an annualized basis, production is now growing by 2.1% a year. The PMI confidence index rose to 55.2 in June, a month-on-month increase, and well above the 50 level that indicates rising output. Consumer confidence, measured by Italy’s National Institute of Statistics, rose to 106 in June, while business confidence was up as well.
True, unemployment is still rising — it went up to 11.3% in May — but the forecasts for growth this year are still going up. The Bank of Italy has this month nudged up its 2017 forecast to an expansion of 1.4%. That is hardly a miracle, but keep in mind that this is Italy. That would be its best result in a decade.
You can already see signs of that in the Italian markets. The benchmark FTSE MIB index is up by 11% this year, and by 28% over the last 12 months. That is better than its peer group. Germany’s DAX (XEX:DX:DAX) index is up 9.8% since the start of the year, and by 25% over the last year. France’s CAC-40 (PAR:FR:PX1) is up by 7.5% this year and 20% for the past year.
Of all the major eurozone equity markets, Italy is already starting to pull ahead of the pack.
Can the Italian economy witness a sustained recovery? There are three reasons for thinking it might.
First, it has started to clean up its banking system.
Last month, the government pumped billions into a rescue of two failing regional banks, marking the first stage of what looks like being a long and costly bailout of its financial system. The impact on the sector has been dramatic. Shares in Ubi Banca (MIL:IT:UBI) are up by 60% this year, and the far larger Unicredit (MIL:IT:UCG) is up by 24%. It may never get to the point where credit is flowing to small companies in the way it should, but at least it will be a lot healthier than it has been for the last few years.
Second, the European Central Bank’s aggressive program of quantitative easing has started to have an impact.
You can’t print €2 trillion of new money without some of it getting through, and, although it has taken a long time to come, it finally seems to have ignited a recovery. It is hard to say exactly how much of that money has flowed to Italy, but the country’s Target 2 balance with the ECB, which settles cross-border payments within the eurozone, has been growing dramatically month by month . It seems clear that a huge chunk of that money has found its way into the country.
Finally, Germany and France look to be finally ready to reform the eurozone.
A common fiscal policy is desperately needed to recycle Germany’s crushing trade surplus towards the periphery — in effect, German taxes need to be spent in poorer countries, the same way some of California’s federal taxes are spent in Alabama or Mississippi. The biggest beneficiary of that? Italy, and especially southern Italy. Even relatively modest transfer of 1% or 2% of GDP would make a huge difference.
Throw those three together, and add in a measure of what, by Italian standards, looks like political stability, and there is no reason why it shouldn’t expand by at least 1.5% to 2% a year. That isn’t great — but it is a lot better than nothing.
After a miserable two decades, Italy is understandably cheap. Taking a range of valuation methodologies, Germany’s Star Capital ranks it as t he fifth cheapest market in the world out of 40 on its radar — it is just ahead of Hungary but behind Poland. The closest major market is Spain, down in the 10th place.
But the market is home to some great companies. The FTSE MIB includes Yoox Net-a-Porter , the world’s leading online fashion business, Campari Group (MIL:IT:CPR) , a formidable drinks company, and the fashion brand Moncler (MIL:IT:MONC) . They have been largely ignored — yet deserve more attention.
Italy is never going to genuinely thrive within the eurozone. It is the wrong currency, and it will struggle to restore the growth of the 1980s and 1990s. But that doesn’t mean that it can’t do a lot better in the next five years than it has in the last — and investors can profit from that.