Tag Archives | Italy

He’s Back: What Silvio Berlusconi Means For Italy and the Euro Crisis

Part of me really missed the guy.  There was something naturally endearing about Silvio Berlusconi.

Perhaps it was his ability to charm women 50 years his junior or his complete disregard for the conflicts of interest involved with being your country’s national leader and one of its richest men and the owner of its most influential media group.  Or maybe it was his willingness to change the laws of his country on a regular basis to protect himself from criminal prosecution or the fact that he ruled Italy—the third most powerful country in continental Europe—like a mafia don.  Through it all, naughty ol’ Silvio seemed to prove that, with a few winks and nods, a ton of money and a total lack of shame or scruples, a guy really could have everything he wanted in life.

On a serious note, I was not happy to see Mr. Berlusconi reappear on the political stage. It is a potential disaster for Italy, the Eurozone, and investors around the world.

Berlusconi’s party withdrew its support for Italy’s technocratic prime minister Mario Monti—the one political figure in Italy that both the international bond market and the other leaders of Europe took seriously—prompting Monti to turn in his resignation over the weekend.

Not surprisingly, Italian stocks sold off Monday morning — the iShares MSCI Italy Index (NYSE:$EWI) had lost more than 3% before recovering slightly by midday — the euro fell, and Italian bond yields shot up.  And across the Mediterranean, Spanish stocks fell, and Spanish bond yields rose.

The market is not happy about Silvio Berlusconi’s return.  The fragile peace we’ve had for much of the past year has been due to a belief that we finally had an adult running Italy.  Bond yields had been steadily dropping as a sign of confidence in Mario Monti and his austerity reforms.  An Italy without Monti is the same dysfunctional Italy that ran up debts of 120% of GDP while showing no real GDP growth in over a decade…proverbially fiddling while Rome burned.

Berlusconi will not win the upcoming election.  His party is a tattered mess, and most Italians are sick of the man.  And Mario Monti may yet stage a comeback, either as the head of a centrist movement or as a finance minister in a center-left government headed by Pier Luigi Bersani.

But Berlusconi’s presence is enough of a distraction to have the markets worried.  My fear is that he rattles the bond market out of its complacency and creates another self-reinforcing cycle of loss of confidence leading to higher yields and vice versa.

It’s too early for me to recommend dumping European stocks just yet.  Thus far, the market seems to have confidence in ECB President Mario Draghi’s ability to keep the entire dog and pony show together with creative monetary policy, and Europe’s leaders are slowly muddling through to a political solution to the debt crisis.  But given the ability of investor sentiment to turn on a dime, I would recommend tightening stop losses.  Or at least start keeping a closer eye on your European stock holdings.

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This article first appeared on InvestorPlace.

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Schizophrenic Bond Vigilantes and Other Market Tales

Not the Bond vigilante you had in mind?

Sometimes it is really hard to believe that Wall Street is run by serious, highly-educated professionals.  You wouldn’t hear a doctor use a ludicrous expression like “Santa Claus Rally.”  You wouldn’t take an accountant seriously if you heard them utter pithy nonsense like “Don’t frown, average down” or “Buy on the rumor, sell on the news.”  And you might assume your lawyer was a closet pervert if you heard him speak of “double bottoms,” “higher highs” or “violating the lows.”  Yet such is the vocabulary of the men and women of the investment profession.

And if the practitioners seem to make little sense, it is because the markets that they follow make little sense.  Stocks soared on Monday, breaking one of the worst seven-day stretches in recent memory.  The catalyst?  An unsubstantiated rumor that the IMF would be giving Italy an emergency loan.  (The IMF denied the rumor, by the way.)

Don’t waste your time trying to make sense of this or trying to establish cause and effect.  It will never make sense because traders don’t really react to information.  They react to each other.

The debt is just this big, yes?

The European crisis is a case in point.  Italy is sliding towards default because its demise has become a self-fulfilling prophecy.  Yes, Italy has shamefully high levels of debt due to years of irresponsible governance (thank you, Mr. Berlusconi).  But then, so does Japan.  Japan’s public debt is 220 percent of GDP compared to Italy’s 120 percent of GDP. Italy, unlike Japan, is also running a primary budget surplus.  Before interest costs, Italy’s books are in the black.  Japan certainly cannot boast this. Yet Japan remains a “safe haven” while Italy is on the verge of meltdown.

Why?  In the circular logic of markets, Japan is safe and can continue to service its gargantuan debts indefinitely because the interest rate it pays is low.  Rather than rates adjusting to the perception of risk, the perception of risk has adjusted to an environment of low rates.  Yet this circular reasoning flows the other way in Europe. Italian yields are not rising because Italy has suddenly become riskier.  Italy has become riskier because rising rates make it harder for the country to service its debts.

One might conclude that the so-called “bond vigilantes” suffer from severe schizophrenia.

As investors, we can learn a few important lessons from this.

  1. When you borrow money you subject yourself to the often cruel whims of the capital markets.  This is as true for countries as it is for companies and individuals.
  2. Risk has a price, and you should never pay too much for it.  Neither party is likely to come out well in the end.

If bond investors had demanded higher borrowing rates from Italy years ago, we wouldn’t be in this mess today.  Italy would have been forced to borrow less money and live within her means.  Likewise, when investors shower companies with capital and bid their stock prices to ridiculous levels, both the investors and the company suffers.  Management makes suboptimal decisions and the investors generally see poor returns going forward.

Government debt has, in the words of newsletter writer James Grant, moved from offering a “risk free return” to a “return free risk.” 

With all of this said, where should investors put their money?  Staying in cash is not a viable long-term option, and investors would be out of their mind to put money in most bonds at current prices.

Given that this article has focused on the irrationality of markets, my answer might surprise you.  I recommend that investors turn to equities.

This is not a call to simply buy an S&P 500 index fund and “buy, hold and pray.”  Instead, I recommend that investors specifically pick and choose low-debt companies that were able to raise their dividends in the crisis years of 2008 and 2009.

Any company able to raise its dividend during the worst financial crisis in 100 years is a company that can survive anything.  Even the destruction of the euro.  And given that many stocks trade near valuation lows last seen three decades ago, your chance of permanent or long-term loss would seem to be small.

Some candidates to consider: McDonalds (NYSE: $MCD), Wal-Mart (NYSE: $WMT), and Walgreen Co. (NYSE: $WAG).  All three have raised their dividends every year for the past decade, and all three currently yield more than the 10-year bonds of the United States, Germany, or Japan.

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