All Roads Lead to Rome, Part III — Michael McTague

Image: The Pantheon, Rome. Source: Roberta Dragan / CC BY-SA (https://creativecommons.org/licenses/by-sa/2.5)

July 2020 — Myth Buster

This series uncovers insights about money, investing and the future with a focus on Italy. (See Part I and Part II of the series.) Just a few years ago, the euro’s many critics were predicting the end of the euro and a return to national currencies. They have returned recently with the same message. Wow, did they get it wrong, about on a level with those who said color TV was a fad. The mighty euro is here to stay.

Beyond the damage done by the coronavirus, Italy’s near term financial future remains at risk. The nation stands at a crossroads. It may shift toward creating wealth through hard work and saving money, or it may push for greater safety nets. The decision resembles conditions inside the US and other economies struggling to regain their equilibrium, where part of the population looks to build personal wealth while others seek to share the collective wealth. As of April, Italy’s unemployment rate hovered around 13%. And the effects of the coronavirus continue to dig in financially.

The fundamentals of the economy remain critical. Italy’s government is making a decent effort to deal with the crisis. Here are some of the ideas they are working on:

• VAT (Value Added Tax) to be reduced
• Lower income tax rates for middle income earners
• Deficit target raised by at least 16 billion euros
• Loan losses removed from bank profit and loss statements
• New Internet tax

Investors will see that these clever measures may ease the pain. The underlying flaw, however, remains the continuing desire to spend more money, especially severe for a country that relies on travel, tourism and luxury goods.

Bailout Possible

As of the date of this article, the euro zone’s response to Italy’s predicament is not complete. A $41 billion dollar investment initiative is under consideration. Here are three reasons why a “bailout” from the euro zone will not solve the problem.

First, the euro zone reacts slowly. It remains stuck in bureaucracy. Germany has the money. The official euro zone leaders add another level of approvals.

A second hampering effect is the sheer size of the wealthy European core. Each major country spans tens of millions of raucous financial cousins. A $41 billion dollar package spread around a nation of 61 million people amounts to no more than icing on a cake — maybe just icing.

The third reason is the limitations of cheap money. In the US also, cheap money is immediately put forth as a solution. The Federal Reserve in an “emergency” move lowered interest rates in the US to 0 – 0.25% on March 15. History shows us, however, that cheap money does a better job of enriching the wealthy than helping those who need cash now.

Roughly half way through the year, the Italian economy reveals a curious split of fortunes. Ferrari continues its 2019 success. Despite an unavoidable drop this year, the stock is up about 15% over the last twelve months. Here are two excellent pieces of news for Italy. First, it shows that luxury goods can hold their own. Second, Ferrari is doing well against its giant, long-standing auto manufacturing rivals. Ford, General Motors and Volkswagen are having big trouble with Ford slipping into junk bond territory with its deflated market capitalization, recently down to a measly $15 billion. (Ferrari stands at $40 billion.)

The split of fortunes, however, shows itself in the shrinking prospects for other Italian companies. Telecom Italia has slipped as normal business freezes from the pandemic. Similarly, Assicurazioni Generali is trading near its 52-week low. Enel SpA dropped this year along with other stocks and is about where it stood a year ago, which means it lost all of its gains over the last twelve months. Enel is also saddled with substantial debt. Unicredit seeks additional funds to make more loans. So, the businesses that gain most of their revenue inside Italy are hurting.

Time will tell whether Italy will solve its financial problems by tapping into outside wealth or inside thrift.

Italy advances through the growing prosperity of the euro zone. Risking a loss of that bounty would prove a miserable option. In addition, the pain of overspending can be found in areas voters do not want to hear about such as lower national reserves, higher cost of debt and a tendency for welfare spending to continue and to increase. Italy’s ten year bond interest rate stands at 1.98%, which is good for the time being. Spending on unemployment does not shrink unless a significant improvement occurs in the economy. The faster the turnaround, the better. The lower the level of bureaucracy from the euro zone, the better.

No More War

There is one interesting message in Italy’s plight. There is no talk of war, except for raucous headlines that refer to “Trade War” and “Cold War” between the US and China. There are no strike-threatening marches by impoverished unions across Europe or in the US. Union membership is shrinking. Manufacturing has long since shifted to other parts of the world. For a variety of reasons, manufacturing employment and productivity have taken a nose dive for months. Even so, there is not much impoverishment. Most people worry about retiring to their homes on the Mediterranean or in Florida. Now all western countries are locked into the pervasive search for wealth. Here is a note from Florida Realtors: “The median home price rose 8% year-over-year in March [2020], according to the National Association of Realtors (NAR).”

An interesting myth. We found attractive features in Italy, but below the surface, the economy moves slowly, reflecting a general trend across the western nations. Italy remains in position to tighten its belt. Of course, that may lead to very slow repair of an already sluggish economy.

Next month, the Myth Buster returns with new business insights.

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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