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One of the major differences between Greece and Italy is credibility
December 1, 2011
Editor’s Note: The following Outlook 2012 report was written by McLean & Partners, a Calgary-based firm specializing in wealth management.
CALGARY, AB, Dec. 1, 2011/ Troy Media/ - The world served up enough headline news in 2011 to put even the most seasoned investor on edge. Economic challenges, political upheaval, social unrest, and human disaster all seemed to play contributing roles in heightening the volatility of the markets.
In the following series, Outlook 2012, we’ll explain why we believe Italy is not destined to follow the path of Greece, and why we believe the Eurozone will stabilize. We’ll outline how the economies of Canada and the United States will offer modest growth, and why China will likely deliver superior market performance in 2012.
Our series will highlight four important investment themes we believe will be key contributors to portfolio performance in 2012, including: Technology, Select Financials, the Emerging Consumer, and Corporate Debt.
Of course, there are always concerns to bear in mind as you manage your portfolio, and 2012 will be no different. In Outlook 2012, we’ll share our top three red flags, and what they mean to you.
Let’s take a look at Europe first, where developments in Italy are raising fears that it is headed down the same path as Greece, which would spread contagion throughout Europe and the rest of the world. We believe not.
One of the major differences between Greece and Italy is credibility. As Greece was given more funds and promised to adopt new austerity measures, Greek bond yields rose, reflecting a lack of investor confidence. In contrast Italy’s credibility has recently been boosted by the resignation of Prime Minister Silvio Berlusconi and the formation of a new governing coalition.
Italy also has unique access to an International Monetary Fund (IMF) credit line of U.S.$385 billion, which has caused Italian 10-year bond yields to subside from a recent spike of 7.5 per cent to around 6.5 per cent. [Fig. 1]
In addition, the Eurozone has significant liquidity to stabilize bond yields in the form of the European Financial Stability Facility (EFSF), the European Stability Mechanism (ESM), and the European Central Bank’s (ECB) bond buying. The level of 10-year bond yields in Italy is an indicator we watch very closely and is a very important factor that reflects investor confidence in the country.
Other differences between Greece and Italy are telling:
1) Italy is better positioned to improve its economic picture. It has the third-largest economy, with the second-largest manufacturing base in Europe. It also has the ability to implement tax and employment reforms to improve efficiencies and future growth.
2) Italy’s debt-to-GDP ratio is 119 per cent, compared with 153 per cent for Greece.
3) Unlike Greece, Italy is one of Europe’s biggest savers, and over 45 per cent of Italy’s debt is owned by domestic investors and institutions, rather than by foreign entities, making it easier for Italy to restructure and deal with its debt holders, if necessary. Looking at Italy’s debt schedule, and assuming implementation of the recently-approved financial stability law, we believe Italy can bring their debt-to-GDP ratio below 100 per cent in seven years. [Fig. 2]
In early October, market consensus believed that Europe did not have the political will or cohesiveness to take resolute action on its debt problems.
We did not agree then, and we continue to hold that view today. For the reasons cited, we believe Italy will be the turning point on the long road to rebuilding investor confidence in the Eurozone.
That said, Europe’s sovereign debt crisis will be a constant drag on its economic performance in 2012. [Fig. 3] Eurozone purchasing manager indices (PMIs) have recently dipped below 50, indicating economic weakness in the months ahead, and Europe is likely headed for a mild recession in 2012.
In recognition of this weakness, the ECB cut interest rates by 25 basis points in early November, in an unexpected move to stimulate economic activity. The ECB also has room for future cuts, if necessary. [Fig. 4]