HOW TO ESCAPE THE VICIOUS CYCLE CREATED BY LIQUIDITY

Global market performance from the start of 2020 was inevitably affected by the outbreak of Coronavirus infections, a pulmonary illness from the same family as SARS which has been a fixed feature in financial and general news headlines since 20 January, with over 900 deaths and 40,000 infected. The good news is that the rate at which infections are increasing is coming down day by day, which seems to indicate that the peak in the spread of the virus should be reached quite soon. Speaking of the Coronavirus, the real question mark for markets does not refer so much to the first quarter figures, which were already expected to be negative, but rather for how long Chinese demand will remain frozen due to fear of contagion. Just days before the outbreak of the pandemic, the European market was performing well (up approx. 2% YTD), driven by IT, Utilities and the Health sector, with the worst performers being the Auto, Chemical and Banking sectors. Fast forward to mid-February and the market reverted to a few basis points from the maximum levels, driven again by the same sectors, with a recovery in banks, and significant worsening recorded in the Transport, Travel and Energy sectors.

The FTSE MIB, in particular, showed a notable increase at the start of the year (approx. 4.5% YTD), recording the best performance among the European listings and coming close to the historic resistance of 24,500 points. The best performing sectors were Utilities (up approx. 15% YTD), IT (up approx. 12% YTD) and Consumer Goods (up approx. 10% YTD), followed by the Health, Banking and Raw Materials, which were all in positive territory. Whereas, Telecommunications (down approx. 11% YTD), Energy (down approx. 7% YTD) and Discretionary Consumption (down approx. 2% YTD) were the three worst performing sectors due to specific problems with Telecom Italia, the drop in the price of Oil due to the virus and luxury brands’ exposure to Chinese demand, respectively. Going on to analyse the capitalisation component, we note instead the net overperformance of Large Caps versus Small Caps, as seen in the negative YTD performance of the FTSE Italia Small Cap and FTSE Italia Mid Cap indices. This represents a return to the trend over the last two years, which was only momentarily broken towards the end of 2019 with the encouraging news on the PIR (Piano Individuale di Risparmio – individual savings plan) regulation (that also remains a positive catalyst for 2020).

This is mainly attributable to the rotation of flows that are leaving traditional funds and going into ETFs and themed funds. The need to invest in highly liquid securities on the part of passive funds, thus excluding a priori the greater majority of companies listed off the FTSE MIB, creates a viscous cycle, making the other indices increasingly illiquid. Added to this is the obsessive and growing level of attention focusing on ESG issues, which translates into investments in companies with sustainability reports and ESG ratings issued by certain specialised international agencies. These prerogatives actually represent a minor cost for larger companies, which had already moved in this direction, but impact heavily on the position of smaller companies, which are only now starting to promote their environmental, social and governance initiatives. In terms of fundamentals, however, there is growth that distinguishes many of the quality Italian SMEs and which represents an opportunity for anyone able to invest over a reasonably long time frame (for example, ELTIF funds), pending the correction of this market anomaly.

With roughly 1/3 of companies having disclosed their results for the last quarter of 2019, a picture of the figures for this reporting season is beginning to emerge. As a general trend, there is a good percentage of upbeat analysts who had probably been cautious about raising estimates on the numbers they had previously cut back on and which are now performing better than expected. The most unexpected feature is the good performance by banks, which benefited from the low spread to perform well in trading, but which, in certain cases (like Intesa), also managed to improve their net interest margin, namely the better quality profit portion, and to increase distribution to investors with dividends and buy-backs (like Unicredit).

Interview with Massimo Trabattoni, Head of Italian Equity.