Italy in Perspective
November 15, 2011
Italy is not Greece because the government is not really broke. Sure they've made too many promises and government debt at 120% of GDP is simply too high if they want to grow the economy, which they must do. But no, they aren't bust--yet.
Italy has world-class companies: ENI, Fiat, Luxottica, Prada, and Pirelli to name a few. As is the case in the United States, non-bank corporations have rarely been as financially strong as today.
Italians are comparably rich, with "average" household net-worth of some $475,000. This household wealth exceeds total national debt by a factor of 4X, according to the Bank of Italy.
But Italy's facing a crisis because its sovereign debt load has come into focus. As with the United States last summer when it lost its Triple-A rating, the ability to pay debts is not so much the issue. What has rattled markets: the willingness of Italy to pay its debt is in question.
Italy, like the US, needs to cut governmental fat, implement structural reforms, and get politicians to stop bickering, and start doing the right thing. No small task.
For a very long time, up until the financial crisis of '08, politicians were nearly irrelevant. Globalization and de-regulation had fostered the “Great Moderation” and other bounties.
But the world has changed. The agenda is now controlled by politics. More now than at any time since at least the 1970s, if not the 1930s, politics matter because only politicians can solve what ails our world. Business is no longer in the driver's seat.
Investors crave stability; so high levels of market volatility reflect a lack of faith in our political system to solve the pressing problems of the day. But common sense says problems eventually do get solved.
Meanwhile, dividend yields on European stocks are higher than the yields on safe government and many corporate bonds. Earnings-based valuations are at a 28% discount to the 40-year average, according to DataStream.
In short, European companies are inexpensive by historical measures.
Admittedly European stocks were cheaper back in March ’09 than they are right now. Otherwise, one needs to go back to recession bottoms in the 1970s and early '80s to find valuations significantly lower than today.
It’s worth noting: when stocks hit those deep recession bottoms in 1973-74 and 1980-82, government bond yields, at 10% plus, were higher than the then current dividend yields on stocks.
Today, government bonds yield 3%. And many great European companies pay dividends in the 5-6% range.
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