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Positions in Europe: Short Italy (EWI); Short France (EWQ); Long German Bonds (BUNL)

This afternoon Keith shorted Italy in the Hedgeye Virtual Portfolio with the etf EWI broken on its immediate term TRADE and intermediate term TREND levels (see chart below). Our thesis on Italy remains intact: the country’s public debt overhang will continue to compromise growth and reduce tax receipts. PM Mario Monti has followed through on a sizable austerity package and recently has been a strong voice for the camp that suggests Europe needs a Growth Pact (beyond fiscal consolidation) as it attempts to alleviate its sovereign debt and banking imbalances.

Shorting Italy: Trade Update - 11. italia

To date there’s been no mention of a public works projects, but we wouldn’t rule one out over the next months given the likelihood of politicians to cave in the face of riots and strikes against austerity. To this end, just this weekend European Economic and Monetary Affairs Commissioner Olli Rehn called for additional government spending on large-scale infrastructure projects, arguing there was insufficient demand in the private sector to create jobs.

Italian fundamentals continue to look extremely challenged: PMI Services declined substantially month-over-month to 42.3 in APR vs 44.3 in MAR and Manufacturing rolled heavily to 43.8 in APR vs 47.9 in MAR, and both have been under the 50 line (representing contraction) since JUN 2011. And we’ve seen similar downward trends across consumer and business confidence surveys. Less current but important indicators like the unemployment rate and inflation rate have remained sticky and high over recent months, currently at 9.8% and 3.8%, respectively.

We see Italy, much like Spain (EWP) and France (EWQ), as a potential short on equity market strength as there exists underlying imbalances (like high debt, deficits, and unemployment rates; banking leverage to housing and property prices that have further room to fall; and potential for further credit ratings downgrades and the inability to raise debt at manageable yields) that are not all priced in and may drag growth lower than forecast.

Matthew Hedrick

Senior Analyst