Triggered by Italian banks, the wave of pessimism that submerged indexes on the Old Continent in recent weeks soon hit European financials and other sectors as well. If the losses were the most dramatic in Europe, it was because this area is seen as more vulnerable due to the inability of EU member countries to reach a convincing agreement on myriad issues: from the bad bank agreement to the bail-in directive and how to manage the migrant situation; from Europe’s deposit guarantee system and the debate on limits to banks’ investments in government securities to the extreme possibility of Athens and London leaving the European Union.
The agreement that the Italian government and the European Commission reached on the guarantee mechanism, which should enable banks to more rapidly clear their books of impaired assets, does not resolve the problem. If banks were given the time to gradually assimilate non-performing loans they would probably not have such great difficulties, because accruals and collateral are more than sufficient, as even Mario Draghi, President of the European Central Bank, has noted. However, while on the one hand, the bad bank deal makes it easier for banks to find buyers for non-performing loans, on the other, it risks requiring banks to sell bad loans within a relatively short period of time, forcing them to recognize additional losses in their books. As if this weren’t enough, rumors about a potential break-up of the Eurozone are resurfacing. The Italian market is highly liquid and it is an inevitable target when things start to go poorly.
Moreover, in the world of QE, equity indexes are extremely sensitive to uncertainty. For example, the significant correlation between equities and oil prices reflects suspicions that the financial sector is excessively exposed (especially in the US) to the energy industry. A few economists have even returned to their projections of another recession. There is no doubt that growth is slowing in the United States as well. This is making investors jumpier, as it puts the recovery at greater risk of a shock due to external factors.
In this scenario, anyone considering a repositioning on the Italian stock exchange, known as Piazza Affari, should take it slowly. Attractive buying opportunities could arise from this point on, but investors will need to be very selective, take a long-term approach and avoid following a short-term rally. In particular, we are keeping a close eye on certain industrials. The situation in the banking sector is still extremely confused. And it is still too early for the oil industry.
By Massimo Trabattoni, Kairos Manager of Italian Equities, for AdvisorPrivate’s Italian Times column.