By Brett Arends, MarketWatch
BOSTON (MarketWatch) — They say the time to buy is when there’s blood in the streets. In the case of Italy, are we there yet?
If you want to go against the herd and buy into Italian equities, good luck. My contrarian instincts want to do the same. Italian stocks have dropped a long way. Everybody hates them. No portfolio manager anywhere can afford to buy them with other people’s money, because if he’s wrong he’ll lose his job.
So maybe this really is the time to buy. And maybe I’m just overthinking it. But here are sevens reasons for brave contrarians to take a deep breath before plunging in.
1. The market is cheap, but it’s not really, really cheap. The Italian stock market XX:FTSEMIB +2.12% now trades at about eight times forecast earnings, says FactSet. Yes, that’s a good deal. (A crude rule of thumb has traditionally put “fair value” for equities at around 12-13 times.) But it’s not a one-way bet. In a crisis I want things really cheap. In the 1998 Asian Tigers meltdown, stocks in Thailand hit four times forecast earnings. In 1998, South Korean equities bottomed out when enterprise values — the value of stocks plus all their net debts — hit 0.7 times company sales. In Italy, today, they’re still 1.1 times. The Italian market today sports a dividend yield of 5%, assuming those dividends are paid. Again, that’s good, but in the financial crisis a couple of years ago it went into double figures. I’m greedy. To go all-in I want things really, really cheap.
2. Watch out for those financials! While the market may look cheap, a substantial chunk of it consists of banks, insurance companies and other financials. As we’ve learned anew in recent years, bottom-fishing financial stocks is about as safe as extreme spelunking — after downing a few beers. (Ask anyone who bottom-fished AIG, Lehman Brothers, WaMu, Bank of America, Citigroup, and so on). Financials make up more than a quarter of the Italian stock market by valuation. As of Oct. 31, they made up 27% of the iShares MSCI Italy Index Fund EWI +3.42% . A retailer or energy company whose stock has dropped 70% may be cheap. A bank stock that’s done the same may be on its way to 100%. Caveat emptor.
Who is Mario Monti and does iIt matter?
Former European Commissioner Mario Monti is in the frame for the top post in an Italian unity government. But does it matter? Senior columnist Alessandro Pasetti suggests that Italy will produce a surplus in the coming years, and unlike Greece, can service its debt.
3. We’re not even in the 75% club yet. A wise old investor I know likes to argue that you should typically invest in a collapsing stock market after it’s fallen about 75% from its peak. The Italian Mibtel index peaked at 49,355 11 years ago (and got nearly as high again in 2007). It’s now just 15,071. That’s down 70%. We’re close. But not quite there yet. And the 75% rule, if anything, gets you into a lot of financial crises too early. On FactSet I had a look at where stock markets bottomed out during other crises in the past 20 years. Like Mexico in 1994, Thailand and South Korea in 1998, and Argentina in 2002. What did I find? Most fell 85% or more. The differences may not sound huge. But they are deceptive. If you buy a market after it has dropped from 100 to 30, by the time it bottoms out at 15 you have lost half your money.
4. The best quality stocks are holding up. Sure, the market overall has tumbled about 25% so far this year. But look at Luxottica LUX +0.13% , the luxury sunglasses (and LensCrafters) company. Its American Depositary Receipts started the year at $30. Today they’re … $28. Telecom Italia TI +4.26% has merely fallen from $13 to $11.50. Or consider Eni E -0.29% , the Italian oil and gas giant. The ADRs started the year at $43. Now they’re $42 and change. It’s not much of a discount. Some of these stocks may be good investments here. Eni is just seven times forecast earnings, yielding 4.5%. Telecom Italia, also about seven times earnings, yields 5.5%. But they scarcely look distressed.
5. How can the economic crisis end here? Italy’s gross government debt is about 120% of gross domestic product, says the IMF. Maybe a third of it is owned by institutions outside the country. And Italy, of course, cannot print its way out of the problem — as America can — because it does not control its own currency. Furthermore, as we all know, Italy is not alone. Greece, Portugal, Spain and Ireland are all in distress and some of the other countries are feeling the squeeze. Meanwhile the people supposed to be running Europe are playing like the Bad News Bears. There is no reason to think this crisis is ending here. And if it gets worse stock prices will suffer.
6. We’ve had panic, but not yet capitulation. See the points above. Capitulation is a mood rather than a data point. It’s hard to define perfectly or to observe. Nonetheless in the current situation the only individual in Italy who seems to have thrown in the towel is Silvio Berlusconi. We haven’t had a spectacular bankruptcy yet. And international creditors are still willing to lend money to the Italian government for ten years at just 7% interest. Some crisis. Italian equities have fallen a long way. And maybe long-term investors will do OK buying here. But the really easy money comes when investing feels harder than this.
7. Watch out for the currency. One way that Italy — and Europe — is likely to earn its way out of this crisis is by devaluing its currency. That might mean Italy dropping out of the euro and restoring the lira. Or it might mean the European Central Bank printing trillions more euros to reflate the economy. Either way, the currency in which Italian stocks are quoted is likely to drop in relation to dollars. And that means U.S. investors may end up giving back on the currency some or even all of what they gain in the nominal value of the stocks. Ultimately you may still be a net gainer, but it will eat into returns.
As I said, some Italian stocks may be a good long-term buy from here. But don’t think they can’t get cheaper.
Brett Arends is a senior columnist for MarketWatch and a personal-finance columnist for the Wall Street Journal.
