First, November industrial orders, understood to be a leading indicator, fell 0.5%. This follows the 1% drop in November industrial output, reported earlier in the week (the market expected only a 0.2% decline).
Of note the weakness in industrial orders was not a reflection of the lack of competitiveness of the Italian economy. Foreign orders rose 4.1% in November after a 7.1% gain in October. The problem is the absence of domestic demand. Domestic orders fell 13.5% after a 4.7% declined in October.
Unappreciated by many is the fact that the Italian economy has seen the largest contraction (7%) since the crisis began within the euro zone after Greece. Per capita income is back, according to former ECB’s Bini Smaghi, to where it was in the mid-1990s (talk about a lost decade).
Today the Bank of Italy has read the hand writing on the wall and slashed its GDP forecast for the year from a 0.2% decline to a 1% contraction. The weaker growth is going to translate into a larger budget deficit unless new corrective measures are taken.
Although Italy’s loss of competitiveness is not reflected in the industrial orders data, it is a serious problem. Italy efforts to boost competitiveness have generally lagged within the EMU. Italy’s unit labor costs have risen 30% move than the EMU average and are now the highest in the region. Productivity is the lowest in the euro area.
These problems have yet to be reflected in Italy’s asset markets. The FTSE MIB (40 large cap stocks) have been the best performer of the major European bourses over the past month and 3-months rising about 8.4%.. Over the past 6-months, its 28.8% rise is a close second to Spain’s IBEX’s 30.9% increase. Italy’s debt market is also continuing to outperform. Over the past month, the 10-year yield is off 31 bp compared with 25 in Spain. Its two year yield is off 53 bp over the past month, while Spain’s off 35 bp. Even the 5-year CDS is sitting on the lows since mid-2011.
While the Italian market has been resilient to the economic and competitive deterioration, we suspect that it remains vulnerable. Foreign investors should consider adjusting positions in the run-up to next month’s elections. While the center left PD is still running ahead in the polls, which will likely give it a majority in the lower chamber, the arcane rule are likely to prevent it from securing a majority in the Senate. A deal with Monti’s centrist movement, may force the PD to alienate part of its left wing, though some of Monti’s reforms will likely still be diluted.