February positive for the Italian stock market: banks and cyclicals shine while opportunities remain in mid and small caps.

In February, all the major global equity indices posted positive performances: on the Italian market, the FTSE MIB recorded +6.4% (+8.2% YTD), the Stoxx Europe 600 +2.5% (+4.1% YTD), the S&P 500 +5.2% (+6.9% YTD) and the Nasdaq +5.6% (+6.7% YTD) in local currency (total return).

At the time of writing, the Q4 2023 reporting season is still ongoing and in this phase investors’ attention is focused mainly on the outlook messages that companies will issue for 2024, aiming to ascertaining the buoyancy of end-consumer demand and the soundness of corporate margins in a still uncertain macroeconomic environment.

By way of example, we can note that so far the reaction of banking stocks to annual reporting has been very positive. Although the lenders themselves envisage a return to rate normalisation, most banks (in Spain as well as Italy) are signalling at least stable (or even increasing) interest margins in 2024 compared to 2023 and a positive contribution to profit also from the commission component of revenues.

Also, at the moment some cyclical stocks, as typified by the luxury or beverage sectors, have enjoyed a significant rebound during the month as a reaction to results in line with expectations or just slightly above estimates. However, we do not think this indicates a renewed sector upturn. It is most probably more of a principle of short covering and investor repositioning after the disappointing performance in the second half of 2023.

However, one sector that has underperformed the market since the start of the year is utilities. There a number of reasons for this, including falling energy prices, which is mainly affecting integrated players (i.e. entities that produce energy internally and then sell it) such as Enel and Iren; also, the rise in interest rates, in contrast to the market’s general expectation of stable or falling rates this year; and lastly, the market’s recent preference for cyclical sectors at the expense of more defensive ones (such as utilities).

However, we expect that with rates settling at a level lower than in the past year, the utilities sector could become attractive again.

This would be because of the lower cost of debt and higher value of future cash flows, as a result of lower discount rates.

Turning to market capitalisation, we note that February saw a further widening of the performance gap between large caps and mid-small caps. Since the start of the year, the STAR and AIM indices have recorded losses of 1.70% and 1.1% respectively, while the FTSE MIB has gained significant ground. From our standpoint, the underperformance of small and mid cap companies can be considered a fleeting episode that will fizzle out in the short term. We repeat, therefore, that this represents one of the most attractive buying opportunities for the asset class in recent years. An initial encouraging sign comes from the Russell 3000 index, which as we write, is back at record highs. Another factor supporting the sector could be the annual reporting season, which for the smaller companies will be happening in March.

This will be a further test of the soundness and corporate quality of those names, carefully selected by the Management Team, that have been able to achieve resilient financial results despite the challenges of recent years.

Lastly, we would like to point out that in recent weeks, there have been several takeover bids of listed companies on the Italian market. First off, commodities trader Vitol acquired at EUR 1.75 per share the Moratti family stake in Saras (about 35% of the capital), triggering a takeover obligation at the same price on all the other listed shares. Then Catterton, a luxury sector private equity fund with Louis Vuitton among its stakeholders, presented a cash offer at EUR 43 per share aimed at delisting Tod’s. Finally, Unipol announced a project to rationalise the group’s corporate structure by merging UnipolSai with Unipol: the latter will launch a takeover bid for the UnipolSai shares it does not hold (approximately 14.8% of the capital) at a price of EUR 2.70 each. This pattern will likely continue and accelerate when there is more visibility on downward trending rates involving micro caps as well.

Commentary by Massimo Trabattoni, Head of Italian Equity