With a year-to-date gain of 11.52%, the iShares MSCI Italy Capped ETF (NYSEArca: EWI) is one of this year’s best-performing developed markets single-country exchange traded funds. Some sector-level fundamental factors suggest the largest US-listed Italy exchange traded fund can continue delivering upside.
Italy is still struggling with issues within its banking sector, an important consideration with EWI because financial services is the largest sector allocation in the largest Italy exchange traded fund. The Italian government has been under pressure to calm concerns over its ailing banking system. Financial services is by far the largest sector weight in EWI.
“Intesa Sanpaolo’s planned securitisation of a large portfolio of bad loans supports Fitch Ratings’ view that Italy’s banking sector clean-up will gather pace in 2018,” said the ratings agency in a note out Monday.
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An Important Catalyst for Italy ETF
Healthy banks are undoubtedly an important catalyst for EWI. The ETF allocates 35.77% to the financial services sector, more than double its second-largest sector weight. The aforementioned Intesa Sanpaolo is the fund’s largest individual holding at a weight of almost 12%.
“Intesa is one of several Italian banks that have recently announced plans to accelerate the reduction of their bad loans, in response to regulatory pressure and the Italian economic recovery. We expect banks will seek to reduce non-performing loan (NPL) stocks substantially through further NPL sales, helped by a slowdown in the generation of new NPLs, while economic tailwinds prevail. We forecast GDP growth in Italy to continue at 1.5% in 2018 but to slow slightly to 1.2% in 2019,” according to Fitch.
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Market observers project earnings per share growth for European stocks to remain strong and build upon the success over the first two quarters of the year. In the first half of the year, earnings upgrades were broad and far reaching instead of concentrated to specific areas. Additionally, Italian stocks are attractively valued relative to other developed markets. EWI’s price-to-earnings is just over 13, implying significant discounts to U.S. stocks.
“Banks may prefer to work out NPLs internally rather than selling their NPLs, given the higher recoveries that are typically achieved. Recovery rates for sofferenze averaged about 46% for work-outs, according to 2006-2016 data from the Bank of Italy, but only 23% for NPLs that were sold,” said Fitch.
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