Wednesday, 19 September 2018

Snack on tapas or feast on pasta?

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SwissInvest strategist Anthony Peters says “I told you so” over the relative merits of Italy and Spain

Anthony Peters, SwissInvest Strategist

THERE ARE FEW things more enjoyable than the “I told you so” trade. Of course, we all forget – if we can – all the trades that blew up in our faces (the “I didn’t tell you so” trades) but from time to time you find one that is worth remembering.

Last Tuesday, my fellow IFR columnist Divyang Shah put out a piece suggesting putting on a Spain/Italy widener. “Hmmm”, I thought to myself, “not a bad idea.”

But, I also thought, didn’t I suggest pretty much the same trade – but as a tightener – in November when you couldn’t give away Italian bonds and for some reason everybody though Spain was the better game?

In other words, he is looking for Italy, which is now trading through Spain, to continue outperforming whereas I liked Italy when it was 100bp cheap to Spain.

At this point, I must concede that had one sold Spain for Italy in November, as I would have liked to have done, one would most probably been out of a job by the end of December as the 10-year bond spread widened to 200bp.

But now, just 10 weeks later, the relationship has reversed by 225bp and Italy is trading through Spain, just where, in my opinion, it always deserved to be.

I wrote at the time: “Spain is a different matter entirely. Italy is about more being taken out than is being put in, but there is plenty being put in. Spain lacks the leading-edge companies that Italy has. Sure, the Italian corporate landscape has been shredded by a few oligarchs and it is in vain that one now looks for the likes of Olivetti or Montedison on the board of the Milan Exchange, but Fiat, Enel, ENI, Finmeccanica and Pirelli are still there.

“Italy is an industrial powerhouse – a troubled one, maybe – but a powerhouse, nevertheless. In comparison, you’ll find that only 10% of the IBEX35 index of leading Spanish stocks is made up of industrials and two-thirds of those are construction and materials. The Spanish economy lacks the depth into which it can reach in search of recovery.”

MY VIEW OF this is no different on March 9 this year than it was on November 15 last and, although the impact of LTRO cannot be discounted, I have to look at the potential for recovery over months and years to come.

Italy has been mismanaged for generations and I grew up in an age when the fall of a Rome government was more common than a Derby County victory.

But although I am impressed with the impact of LTRO, solving the banking problem is only a minor part of the overall recovery process.

In automotive terms, the banks are the starter motor but not the engine. They need to have a productive economy to lend to and although large swathes of Italy are spiritually still in the Renaissance, the industrial North is a sight to behold. Follow the Autostrada from Milan to Varese or from Milan to Turin or Como and you drive through miles and miles of factories and warehouses.

There is no shortage of economic activity there and the old adage that if you cut off the boot around Florence, then Italy could compete with Germany is not without merit.

But it’s different in Spain. I do hear that the real estate market is looking as though it is bottoming out but the overhang is so extreme that a recovery in values will have to wait.

Employment levels remain unimpressive and if anyone can see where sustainable jobs growth should come from, I’d love to hear. Italy may be a fiscal basket case but an economic one it is not. I struggle to find the same arguments in favour of Spain.

IN FACT, THE sort of volatility that hit Italian debt should never have happened. First, there was not a lot about the fiscal position that we did not know when the country joined the euro at inception in 1999, although it failed just about any Maastricht test you threw at it and as such not all that much has changed.

It was brought into the single currency by France, which had loudly expressed its fears that its southern neighbour would enter a cycle of “competitive devaluation” which would provide an advantage that Paris had no intention of conceding.

Germany was less concerned but always deferred to France in all matters with respect to European affairs.

Second, benchmark-huggers can’t afford to take proper decisions. How can you position fundamental views, no matter how correct and convincing, if you get measured on a daily mark-to-market? But that is a theme for another day.

In the meantime, stay long Italy over Spain. As I told you 125bp ago.

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