Société Générale’s bearish strategist Albert Edwards devotes a fair amount of space to Italy in his latest strategy note out this morning.
Edwards notes that while European stocks look cheap, Italian stocks look especially cheap on traditional valuation metrics.
Furthermore, Edwards writes, “I believe the electorate were right to reject further austerity. There will be more such electoral revulsion on the way, but for Italy it doesn’t really matter anyway. They can remove the horse-hair shirt forced on them by the ECB/Germany/European Commission and these dreary architects of depression can be told to take a very large running jump. Buy Italy!”
Edwards points out that Italy, despite the fact that it has the second largest debt-to-GDP ratio in the euro zone after Greece, can actually claim some pretty good deficit management relative to other euro member states in recent years.
“Adjusting for the economic cycle, the second table below shows that Italy’s deficit never rose at all from 31⁄2% throughout the credit crisis, in stark contrast to everyone else, who clearly (by definition) were trying to spend their way out of the recession,” writes Edwards.
Photo: SG Cross Asset Research, European Commission
Now, the austerity measures pushed through by former Prime Minister Mario Monti are helping to drive the country further into recession.
Edwards argues, echoing a recent Wolfgang Münchau piece in the FT, that “austerity” and “reform” are two different things.
Whereas Monti’s austerity measures – raising taxes and cutting spending – may improve the government’s finances in the short term, they could cause more damage in the long run.
Structural reforms, on the other hand, Edwards writes, “most especially increased job security associated with labour market reforms – are usually deflationary in the short term and need fiscal stimulus to offset the impact.”
Edwards calls Italy’s troika of creditors at the ECB, EU, and IMF “dogmatic and inflexible” for not allowing these structural reforms in Italy (remember, they cost money in the short run).
All of this leads him to his ultimate conclusion on Italy:
That is why in my view the social disruption will intensify and we will see more Five Star Movements emerging around the eurozone. Italy, with the headline deficit already down below 3% of GDP, certainly doesn’t need further austerity in the near term.
Finally, as we highlighted recently, Europe is clearly cheap both on a top-down cyclically adjusted PE or PCF basis, but also from a bottom-up basis (e.g. the value part of Graham & Rea deep-value screens). And as our European Strategist, Paul Jackson showed recently, Italy is much cheaper than most other countries in a cheap region. Dylan used to say there is no such thing as toxic assets, only toxic prices. The situation in the eurozone is indeed toxic and it will get worse. That is the opportunity. Buy Italy.
“The heavy lifting has been done in Italy,” writes Edwards. “They are, as we say in the UK, done and dusted.”
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