Monday, June 4, 2018

New Italian Renaissance Triggers Equity Market Mini-Selloff

Monday, June 4, 2018 - Headline news around the world continued to drive stocks last week as investors focused concerns on rising US interest rates, new tariffs with allies, increasing trade tensions with China and most unwelcoming, Italy replacing Greece as the new trigger to pull apart the Euro Currency Zone.

Investors returned from the Memorial Day holiday weekend to surprising political news out of Italy that rekindled fears of a Euro crisis not seen since Greece. After a brief sell off Tuesday, investors breathed a sigh of relief with the week ending on a stronger than expected Jobs Report on Friday. US stocks’ resilience continued with the markets eeking out a slight gain on large caps while the broader Nasdaq Composite comprising a significant number of small–mid cap names, as well as, tech companies rose significantly more.

US indexes ended the week barely registering gains for the S&P 500 and the NASDAQ Composite rising to 2734.62 and 7554.33 respectively for a weekly gain of .49% and 1.62%. The indexes recovered being led by Energy and Technology stocks.

Now a word about why Italy matters more than Greece to the Euro….

The Italian economy is larger than either the Greek or Spanish economy within the Eurozone. While more industrial, rigidities in the societal and political sectors have prevented the country from modernizing like its more innovative neighbors. For example, the FTSE MIB Index (originally created by the Milan Stock Exchange) has only one technology stock, STMicroelectronics with a minor 3.3% weighting. The balance of the index is largely in banking (28%), Utilities (17%), Energy (11%), Auto (10%) and Industrials, Insurance, etc. That’s it. One stock is the tech sector.  A cautionary note for investors, the FTSE MIB hit its all time high in January 2000.

For the record, MSCI Italy classifies STMicroelectronics as a French company due to its dual country structure. Hence, Italy suffers from high unemployment particularly among its youth. There is no tech sector to drive the economy and create new wealth. The country runs huge government deficits to cover its social welfare net which has been strained by the influx of African migrants.

Since it cannot devalue its currency to become more competitive to attract investment, the current populist coalition Trumpian-like government has come up with a novel idea to launch a parallel internal currency called the BOT which sent a chill thru the Eurozone. The outcome of this new crisis is likely to be consolidation in the European Banking Sector lead by discussion of the merger between UniCredit and SocGen as well as some type of bailout by Germans and Dutch Governments of the weaker member states although in what form has not taken shape if the Euro is to remain intact.

The announcement of new tariffs on aluminum, steel and lumber on European and Canadian imports added to investors’ concerns. Emerging Market countries like Brazil and Argentina are starting to feel the pinch from a rising US Dollar and increasing US interest rates as well.  The weekend China US trade discussions have been indecisive.  Also, investors should maintain an eye on the stock price of Deutsche Bank, which hit a new low, as an indicator of the health of the European banking system.  These issues will dominate this week’s meeting of the G7.

In fact, we thought the most insightful quote of the week was from Mohammed El-Erian on CNBC:

"The downturn in global markets on Tuesday over concerns about Italy's political power struggle and the possible economic fallout as a result highlights the mistaken assumption that the world was in a phase of synchronized growth,"… People are now realizing the only economy with real legs to it was the U.S. economy."

Little reported was the vote by the Federal Reserve Board of Governors to relax the Volcker Rule that had severely limited banks from engaging in proprietary trading. Once other agencies relax their restrictions, we should see added liquidity to the bond markets. Also, regional banks should start expanding lending due to reduced reporting and stress test requirements.

Given these events, we suggest a mindful eye on tools like our Select List and Risk and Reward Ratings that can be used to evaluate the vast set of opportunities in the ETF marketplace. Investing in ETFs requires a new approach to macro investing, one in which investors are just beginning to realize.

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