Kubie: Riding Italy’s Mend With EWI

April 04, 2014

Is Italy turning the corner? Indications are that it is.

This article is part of a regular series of thought leadership pieces from some of the more influential ETF strategists in the money management industry. Today's article features Scott Kubie, chief investment strategist of Omaha, Neb.-based CLS Investments.

After years of struggling to make the needed reforms, a number of events are pointing to improvements in the Italian economy, and investors are starting to take notice.

As of March 31, the Italian market has risen 14.59 percent so far this year. Using quarter-end data, Italy is ranked second in year-to-date performance and first in one-year performance of the 15 countries in the MSCI Europe Index. But this recent run of good relative performance is a new phenomenon.

Longer term, Italy has been a laggard. Its total return ranks second-to-last over the past five and 10 years of the countries in the same index. While some investors like everything to align before investing, waiting for great conditions increases your odds of getting in after markets have already gone up.

A better approach is to look for areas where conditions are just starting to improve and the odds of reform look high. The poorer long-term returns suggest Italy’s market has a lot of catching up to do. I believe the recent results reflect improved expectations politically, fundamentally and economically in Italy.

The iShares MSCI Italy Capped ETF (EWI | B-89) is likely to be a good tool to take advantage of this still-developing turnaround story. The fund rose by half in the past year, and by more than 14 percent so far this year. But it likely has more to run. Here’s some of the crucial background.

Political Reform

To begin, I believe that the political climate in Italy is improving.

Matteo Renzi took over as Prime Minister after Renzi orchestrated his replacing Enrico Letta as the head of the Democratic Party. Letta resigned on Feb. 14, 10 months after being appointed to office. While Letta had been able to join his center-left Democratic Party into a coalition with the New Center Right party, the pace of reform had been too slow.

Renzi, formerly the mayor of Florence, is only 39 years old and promises more rapid change and a number of key political reforms. Some involve reforming Italian election law so that parties with pluralities above 37 percent can form majority governments rather than being required to cobble together a difficult coalition.

Other ideas include shaking up the power of the Senate and reducing the number of legislators. Italy’s lower house has about 160 more representatives than the U.S. House of Representatives, and its senate is about three times as large as the U.S. Senate. For a country much smaller than the U.S., this points to a bloated public sector.

Renzi is also seeking to improve the justice system to make the country friendlier for business.

Fundamental Reform

10_Year_Italian_Bond_Yields

In recent years, Italy has been under pressure as it finances its deficit because of high interest rates. The yield on Italian bonds has dropped significantly from its crisis highs. By being able to refinance debt at attractive rates, the government can make investments and institute economic reforms with additional flexibility.

 

Find your next ETF

Reset All