The relative performance of an exchange traded fund tracking Italy’s stock market is a warning that Europe’s debt crisis may get worse.
Earlier this month, I put a spotlight on the sharp pullback that iShares MSCI Italy (NYSEArca: EWI) was experiencing relative to the iShares S&P 500 (NYSEArca: IVV) at the time. [Italy ETF Provides Clues]
I posited that should the pullback be temporary and that ratio leadership persist, animal spirits likely would rise again and manifest themselves through risk-taking and stock buying.
Below is a quick update of the chart. As a reminder, a rising price ratio means the numerator/EWI is outperforming (up more/down less) the denominator/IVV.
As can be seen, the ratio has trended lower and is actually reaching towards its all-time ratio low hit in early September.
Much of this relates to the sudden spike in Italian bond yields last week. Italy may have changed everything, ending the continuation of the “fall melt-up” I wrote about here. [Fall Melt-Up Arrives]
The fact that Italy is not only the third largest Eurozone economy, but also the third largest government bond market in the world likely means that as goes Italy, so goes risk-assets.
The importance of Italy can not be understated. Italy is both too big to fail and too big to bail, and despite austerity measures and the end of Berlusconi’s reign, bond investors remain unconvinced.
A number of economists have noted that yields above 6% are unsustainable, and as of writing the 10-year is over 7%. If the yield fever breaks and the above price ratio recovers, markets have a good shot at continuing the rally into the end of the year. However, if yields stay where they are in Italy (and now Spain), I fear we could be set up for a repeat of August and September.
The author, Pension Partners, LLC, and/or its clients may hold positions in securities mentioned in this article at time of writing. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities.