The Italian stock market seems not to take into account the risks facing the economy . Today, its stock index is the highest in the Eurozone as a whole, in an environment in which Italy is in economic stagnation, with a high public debt and with the formation of a Eurosceptic government.  How can this de-correlation between the stock market and the country's economic reality? Are the investors ignoring the Italian reality?
The data of the Italian stock exchange
The FTSE MIB, the selective stock exchange of reference in Italy, is today the stock index that has advanced the most in terms of the year of the Eurozone stock exchange. If we look at the data, so far this year the FTSE MIB adds a return of 10.83% .
If we compare it with other indices, we can see a wide differential in profitability. The EuroStoxx 50 advances 1.76% and the Ibex 35 2.13%, so compared to the Italian stock market are surpassed by eight percentage points in these five months .
Remember that Italy experienced an intense stock market crash between mid-2015 and mid-2016 fruit of the strong deterioration in the banking sector . The total of the doubtful loans in the balance sheets of the banks almost doubled in the five years until 2015, reaching 360,000 million euros.
However, since 2016, there have been increasing efforts for to clean up the balance sheets of the Italian banks . Monte dei Paschi, the third largest bank in Italy, canceled some of its bad debts and embarked on a spree of cost reduction, closing branches and laying off employees. It was rescued by a recapitalization in the form of a cash injection of almost 4,000 million euros from the Italian state, which is now the bank's main shareholder.
Other banks have made similar efforts to reduce the mountain of distressed loans from their banks. books, and have raised new capital from investors, including the Italian state, to avoid bankruptcy. The estimated size of that mountain of bad debts has decreased from its peak in 2015 of around 360,000 million euros, to about 64,000 million euros today .
The stock market is a machine that discounts expectations, therefore, in this context, and with the improvement of expectations in the banking sector, the FTSE MIB index closed last year with an increase of 13.6% the best in Europe and one of the best in the world. But not only that, in 2017, the profits of Italian companies returned to pre-crisis levels and, in some cases, even beyond.
The ability to remunerate investors has increased. The dividend yield of the FTSE MIB, calculated on the share price, stands at around 3.8% being one of the highest in Europe. To obtain at least similar profitability in the Italian sovereign debt segment, it would be necessary to invest in an extremely long maturity term, that is, in a 50-year government bond.
Toxic combination: High debt and growth moderate
The ratio between the public debt and the Italian GDP is 132% levels that are only surpassed by Greece within the Eurozone. The projections in the medium term do not indicate that there will be a strong correction of these levels but that by the year 2021 a ratio of 128.3% of GDP would be seen.
The public debt, as a percentage of GDP, has increased 33 percentage points largely as a result of the sharp fall in revenues public and the reduction of real GDP. The upward trend in the growth of the debt seems to have been reversed, however we must take into account that the high level of public debt at any time, an increase in interest rates is a risk to be taken into account for the dynamics of public debt.
The Italian economy is growing at a very moderate pace. If we look at the data, in the first quarter of 2018 the Italian economy grew by 1.40% year-on-year being the slowest growth since the first quarter of 2017. Even, the year-on-year rate has been decreasing since in the second quarter of last year it marked a rate of 1.70%.
Another negative point for Italy is that it is one of the few OECD economies that, to date, its GDP level has not yet returned to pre-crisis levels the second most significant gap important after Greece.
Political uncertainty goes further
The Five Star Movement and the League – the first was the most voted party in the March general election, while the second won the most votes within the coalition of right- have been in negotiations for more than two months trying to overcome their differences for the formation of Government.
Although the Five Star Movement and the League are not natural partners in the government, they managed to create a government platform that includes a guaranteed income, a setback of the pension reform that It would reduce the retirement age, a fixed tax, the expulsion of illegal immigrants and a closer relationship with Russia.
One of the points they want to address is to reach an agreement that allows Brussels to renegotiate a greater deficit so that the new government can increase public spending more easily. Something that does not end up being understood in a country so highly indebted. The country's public debt is 2.42 trillion euros . For this year the government must face 236.407 million euros and for the next 281.967 million.
However, to date, it does not seem that the investors take into account the political risk and that although both forces were originally parties Eurosceptics, the Five Star Movement and the League have since been divided on the issue of European, so the exit risk of the European project seems discarded .
If we look at risk indicators , the risk premium has a bearish trajectory from the highs reached in 2017 and now, the differential with the bund is 132 basis points . The probability of default marked by CDS at five years is 21.51%, low levels and last seen in the fourth quarter of 2015.