All Roads Lead to Rome, Part II — Michael McTague

Image: Colosseum, Rome. Source: Oliver Lechner / Pixabay

June 2020 — Myth Buster

Last month we took an overview of Italy’s peculiar predicament with a focus on the country’s economy rather than the recent corona virus shock. A large country benefiting from euro zone prosperity, Italy likes to spend when it should save or, to use a popular expression, it zigs when it should zag. Based on euro zone history, while the government flails around in its long-standing urge to spend money, the euro zone will not stand by idly and allow Italy to get into real trouble.

The Myth Buster Bore down on the plight of Greece, which was dragged kicking and screaming into modified austerity. Look for Greece’s neighbor to get similar treatment. Greece is also watching Italy along with Spain and Portugal, whose bonds track Italy’s curve, to see how far the European Central Bank (ECB) will go to tighten the situation. Investors will also take note that Europe’s economy has dropped three times as far as the US economy during these troubled times.

We noted previously Italy’s unattractive fundamentals. Prior to the pandemic, unemployment stood at 9.7%. This enormous rate will soar even as the virus subsides. This also means — as it does across Europe — that youth unemployment is much worse, exceeding 33% in Italy. These statistics build up pressure for discretionary spending to help a large part of the general population who are suffering. The great peninsula’s economy will revive slowly, however, since it depends on the wealth and good spirits of those who travel, take vacations and buy luxury goods. Even the wealthy are holding back.

The sudden change among the rich should be obvious. Here are a few examples. The New York Times ran a headline: “Cruise Industry…Scrambles to Survive.” A recent check of Carnival Corporation’s share price found a 52-week range of $8.00 to $56.00. Norwegian Cruise Line on a recent check was also near its 52-week low with a range similar to Carnival’s. Most of the well-known travel companies are privately owned or not-for-profits. These include Tauck, Road Scholars, Gray & Co. and Classic Journeys, which remain on hold until things change. Airline companies are suffering. Delta’s market capitalization has shrunk to about $14 billion as its share price went down 70% over a period of months.

Hotels are also hurting. Marriott has lost about $70 a share in the last year. Disney’s value has fallen, but the wide-ranging entertainment company has fared better than many in this many-headed industry. SONY has also hung in pretty well, avoiding a huge drop. And AT&T shows a pretty tight share price range. AT&T is down but its range of businesses helps it avoid disaster. In the luxury arena, Sotheby’s and Christie’s are privately held. Their recent sales figures are even more private.

Luxury home sales are locked up tighter than Florida condos in the off season.

Everyone who has a retirement plan is bombarded with emails assuring that everything is OK. Fidelity runs a header that says, “Strategies for uncertain times.” Another reads, “Protecting yourself from fear of loss.” Imagine the marketing/public relations meetings that led to such soft and re-assuring language. One might wonder if the giant mutual funds considered sending white noise CD’s to investors. Assertions of investment excellence are being replaced by “Cash is king.” Gold is back in the spotlight. The ultimate hedge hit its highest level in eight years recently.

Return to Florence?

The Myth Buster has long marveled at the explosion of students taking courses in Italy. Prior to the crisis, 37,000 American students were following this inspired, “cultured” design for learning. Most returned to the US to hear their parents warn against ever returning to the home of the Renaissance. Clever college administrators must be looking for plan B. How about Greece, the land of Plato, Aristotle and the Byzantines? Egypt, the land of the Pharaohs? Imagine the flurry of cleaners, scraping the insides of gondolas and power washing the Ponte Vecchio Bridge in the hopes of a sudden return.

Even more troubling is the country’s proclivity for spending more money than it has. For 2020, the homeland of Michelangelo was expected to dole out $990 billion, creating a projected deficit of nearly $50 billion. The euro zone policy is to avoid a deficit of more than 3% of Gross Domestic Product (GDP). Spending is one issue; debt is another. Debt to GDP is expected to hit 135% this year in Italy. Look for interest rates to rise. Borrowing will not be easy. Yields are falling and the nation is on the brink of slipping into junk bond territory. They recently escaped a downgrade by Standard & Poor’s, but this bears watching. Junk bond interest rates would leave quite a black and blue mark on a country that needs cash desperately.

Where Will These Funds Go?

Social benefits present the real challenge. Prior to COVID-19, with already high unemployment, additional funds were planned for 2020. Also, public pensions are ballooning along with a near lifetime employment guarantee for public employees. A stimulus to the Italian economy would be welcome, but the expenses already exceed the revenue, and the euro zone authorities watch carefully. This brings us back to the slow-moving economy. New markets are difficult to come by and the high unemployment already creates a drag on growth.

Italy finds itself with no escape. The euro zone has proven a windfall to Italy and its southern European neighbors. Now is the time for clear-headed decision making. All roads lead to Rome, even those that begin in Athens, Lisbon and Madrid.

Next month, we will draw a few conclusions as we wrap up this timely series.

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Michael McTague, Ph.D. is Executive Vice President at Able Global Partners in New York, a private equity firm.

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Equities Contributor: Michael McTague, PhD

Source: Equities News