Selectivity and the medium-term time horizon: how to approach the Italian market

26 July 2022
Italian Times

The resignation of Prime Minister Mario Draghi marks a turning point for the country. Draghi ensured international credibility with regard to negotiations with the European Commission and the implementation of the National Recovery and Resilience Plan (NRRP).

In the new political environment, which will lead to elections at the end of September, it will be essential to try to understand the parties’ positions with regard to the European Stability Pact and the implementation of the remaining elements of the NRRP, as well as attitudes towards Europe and the common currency, more generally.

In any case, the Draghi administration will stay with the country until the outcome of the elections and will also continue to act on non-traditional matters (NRRP), thus making the situation more positive than initially presumed. However, the future depends on the election results.

We are therefore entering a phase of uncertainty which, in an exhausted economic environment, does not help. The electoral campaign will generate further uncertainty, and one will then have to understand whether or not a governable country will emerge. Although the limited visibility that there is does not allow for major upswings in the short term, it is also true that the decline in share prices since the start of the year guarantees a sort of share price floor, which is already very low.

Where will we see the impacts? Stocks linked to internal dynamics — those linked directly or indirectly to the performance of the Italian economy — will suffer the most. These include banks, which by their nature, lend capital to Italian companies. If companies start having difficulty, the issue of non-performing loans would be back on the table. However, in the banks’ favour, the current trend is for the European Central Bank to raise interest rates, even if the prospective risk of the cost of credit in some cases and the impact of exposure to BTPs (Italian government bonds) in others are variables which make the banking sector particularly sensitive to the current economic environment.

The European Central Bank has also confirmed that it is raising interest rates by 50 basis points, given the inflation in energy and food prices. This increase was not only higher than the 25 points that the market expected, but it will probably be the first in a series of increases, given that Lagarde has already announced another 0.25% increase to be confirmed during the next session. However, at the same time, a new monetary policy instrument has also been announced, namely the Transmission Protection Instrument. This mechanism, eagerly awaited by investors, should serve to bring stability to the performance of government bonds issued by Member States. On the other hand, however, the ECB’s press release highlighted activation criteria which denote a certain degree of conditionality and quantitative limits which could therefore impede its effectiveness, rendering it a less impactful instrument than the “whatever it takes” approach Draghi was known for.

The coming period will not be easy, but one must consider the fact that, in this phase, any problems linked to Italy could affect the whole of Europe.

For all of these reasons, we remain very cautious and selective on the Italian Stock Market, favouring quality companies with good fundamentals, pricing power and international leadership, which are currently paying for being listed in Italy.

It will be crucial to carefully monitor second quarter reports. Companies present themselves to analysts with estimations that have already been cut, but risk further reduction to levels below the consensus, given the sharp increase in costs. Therefore, it will be important to understand the trend in orders, given the clear slowdown in the economic cycle.

Observing the market and making a careful selection that favours quality on the Italian market, with a slightly longer term view, not looking only to October, but at least 12 months, could bring extremely interesting results in line with the returns in other areas of Europe. If the objective pursued is not limited to only a few months. This is probably a time which could probably make all the difference for returns over the coming years. The Italian economy is full of global leading companies in market niches, with strong pricing power, and these are the companies that should be favoured.

Any improvements at the macroeconomic level, such as a possible truce in the Russia-Ukraine conflict, a reduction in inflation, an improvement in the state of global supply chains or a less severe slowdown in the economic cycle than expected, could lead to a bounce-back for the entire global equity market, bringing Italian stocks with it.

Commentary by Massimo Trabattoni, Head of Italian Equity.