Shorting Italy: Uncertainty Portends More Downside

Positions in Europe: Short Italy (EWI); Long Sweden (EWD); Long Germany (EWG)

Keith shorted Italy via the etf EWI today in the Hedgeye Virtual Portfolio. There are a number of uncertain events surround Italy, most particularly that the country has now joined its PIIGS brethren in the long-awaited spotlight on its fiscal imbalances, which encourage a risk/reward profile to the downside.


Here are the main near term catalyst to get through this week:


1.   Final vote on €40 Billion Austerity Package – The Italian Senate could approve the package of tax hikes and spending cuts tomorrow (Thursday) with the lower house following on Friday. PM Berlusconi has voiced support for the package, calling on short-term sacrifice for longer term stability.


2.   Italy auctions a total of €3 to €5 Billion EUR in 2016 and 2026 maturing debt tomorrow —Questions remain if the offering can find demand and at what yield. Italian yields broke out this week (the 10YR rose above 6%) and we’ll have to wait and see if the ECB intervenes to support the issue.


Shorting Italy: Uncertainty Portends More Downside - 1. italy


3.   Results of European Bank Stress Test Results, Part Deux on Friday (7/15) – We could see additional volatility in and out of the release.  News on Monday that Italian regulators are ordering a new short-selling rule on Italian-listed securities until September 9th sent banking stocks swinging around in the last days. 


4.   Speculation on a tense relationship between Berlusconi and his Finance Minister Guido Tremonti –the Finance Minister admitted to graft late last week, revealing that Marco Milanese, a lawmaker accused of corruption who until early July was his political advisor, had been paying €8,500 a month on rent for his apartment in Rome. This “news” further erodes the lack of credibility in Berlusconi’s government.



Fundamentals and Fiscal Health Remain in Check:


A.   GDP Drag – Even should the new austerity program pass, Italy’s GDP is expected to grow only 1% in 2011 and 1.3% in 2012. We think this number could be revised down as domestic demand wanes alongside further fiscal consolidation (austerity), unemployment rises (at 8.6% but near 30% for persons <25 years), inflation remains above the 2% target, all of which will put additional pressure on the government’s ability to generate revenue and reduce its debt and deficit levels. The government has said it will cut the deficit to 3% of GDP by 2012 from 4.5% in 2010. [Italy’s debt as a % of GDP stood at 119% in 2010—the second highest behind Greece in the Eurozone].


B.   Debt Maturities—While an IMF report on Italy (July 2011) calculates that over 75% of Italian government debt is long-term debt (with average maturity at 7.2 years) and less than 12% of its total debt is at variable rates, the country is coming up against some significant payments in the coming months (see chart below). Based on the recent move in yields and auction results, there’s increased risk that Italy will have more difficulty finding demand for its paper without significantly boosting yield premiums.


Shorting Italy: Uncertainty Portends More Downside - 11. italy


C.   Needy Banks—According to the IMF report, Italy’s five largest banks face large refinancing requirements of over €65 Billion and €104 Billion of bonds coming to maturity in 2H2011 and 2012, respectively.  While Italy’s top five banks are estimated to have only €3 Billion of exposure to Greece, Ireland, and Portugal, across major metric the banks continue to underperform their EU peers, and declining sovereign bond prices will further worsen bank balance sheets.


D.   Bleak Legacy – Over the last decade Italy has proved the relative loser on competitiveness as wages have risen faster than productivity and the gap between Italy and the major economies of Europe (Germany, France, Spain, and even the Eurozone avg) on the metrics of GDP per Capita and Productivity per Employed Person has continually widened. Additionally, Italy ranks near the top of the list across European countries for the oldest population in Europe. Look for this aging population to eat into government coffers in the form of increased spending on pensions, healthcare, and other social services.


Matthew Hedrick


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