Italian investors were faced with huge news a few months ago: the Piani Individuali Di Risparmio (PIR) or individual savings plans has been introduced as a stimulus for Italian mid and small-cap growth and a reduction in taxation with the aim of driving the economy forward.
Unpopulated Stock Exchanges
Italy has relatively unpopulated stock exchanges due to archaic policies that discourage Italian small caps to use the markets as a way to grow. Furthermore, many Italians lack market orientation and do not appreciate the separation between ownership and management.
Italian stock exchanges have seen a string of recent delistings due to the undervaluation hypothesis, high transaction costs and slow bureaucratic system. The undervaluation hypothesis is caused by the country’s risk: according to AdviseOnly from 2000 to 2016, the average annual return of Italian stocks has been -2%, as against the 1.9% of a differentiated basket of shares. From 1900 to 2016, the average annual return has been 2.0% for Italian stocks compared to the 5.1% of world stocks.
The supply of PIRs exceeds demand and contributes to increasing prices. The effects on the market are now visible: since the beginning of the year, the FTSE Italy Mid-Cap index rose by 17%, beating the FTSE MIB index.
Could the Bubble Burst?
But all that glitters is not gold. PIRs have moved roughly €10bn from blue chips to mid and small-caps – a massive, faster than average flow of capital. Fast-flowing money normally creates dangerous bubbles in financial sectors.
This surge could cause the hijacking of small-caps to blue-chips index. This will mean that stocks that pass from small and mid-caps to the blue-chip segment might lose their PIR prerequisites, thereby causing a sharp and unforeseen fall in financial markets.
In addition, the rapid rally in small-caps and rush of funds is sparking worries about a price bubble forming as valuations diverge from fundamentals. The rally has lifted valuations of some companies to extreme levels that are usually a privilege of top luxury groups such as Ferrari or Hermes.
However, price-earnings ratios (P/E) do not increase homogeneously: the FTSE Mid Cap and STAR indices are even higher than FTSE MIB, the main Italian index, which is still suffering from problems related to the banking system.
From a tax point of view, the presumed tax savings created by PIR are outweighed by the high commissions charged by banks and advisors. Italy has a high taxation on capital gains and, like France, implements the useless Tobin Tax – a levy on financial transactions.
Markets have begun speculating on this distortion. However, hedge funds and big mutual funds have not started to go short on Italian small caps yet. Nonetheless, if the rally continues, it will presumably hit a ceiling at some point.
That said, Italian stocks are still cheaper than the German, French and British counterparts. If IPOs and share sales grow, and market deflation follows, the fresh opportunities could attract new foreign institutional investors.