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Kass – An Italian Job?

Written by Doug Kass | Jun, 6, 2018

“What should have happened? First, I think it would have helped to have some perspective on Italy. The country’s gotten pretty dysfunctional, with almost no growth whatsoever. There’s also that aforementioned 11% unemployment rate, plus an immigrant population that all parties concede will cost more than the country can currently afford.

At the same time, Europe’s recent history of chaos has provided multiple opportunities to invest here in America, because you can count on some people panicking over the “black swan theory.” Finally, you can be sure that what happens in Italy won’t be related to any individual companies, as all anyone cares about now are the indices. Those trade both here or abroad as if they’re their own beasts these days, unrelated to anything corporate at all like earnings, or dividends, or prospects.

Now, I concede you can’t not report these things in the media. But I also think that the Italian crisis should have been reported in the light of what it really was — an oddity that produced a quick spike in Italian bonds as a product of a government changeover. Nothing more.

But on a slow news day with almost no earnings and the usual Trumpian trade tensions growing less and less newsworthy, it was something new and exciting to report. And it was easily framed as frightening and worrisome, because there are no consequences whatsoever for it not to be framed that way. If it turned out to be terrible for our markets, the dread would be warranted. But if it turned out to have a positive resolution (which was the case), well, nobody pays for the scare stories.

It’s an asymmetrical standard at work, and the only two things you can do are 1) expect it and 2) exploit it. Otherwise, shame on you for selling given how often these European “woe-is-me” stories burst onto the scene, explode and then recede within a few weeks’ time. Or even less in the case with this particular Italian job”.

– Jim “El Capitan” Cramer  – “Rome’s Political “Crisis’ Was Just an Italian Job” discusses the past week in review – particularly from his vantage point of the Italian “debt crisis.”

I agree with some elements of Jim’s missive and disagree with others.

I agree that the market downdraft provided a short term opportunity in the U.S. – that is about history and about the passive strategies and products that dominate our markets and tend to exaggerate short term moves.

My tactical response, as described in a series of columns last Tuesday was to cover my Spyder shorts for a nice profit, and I went net long in exposure. Seeing the market with no memory from day to day emerge (Tuesday – down big, Wednesday – up big, Thursday – down big) I went on to (incorrectly) scale into a short as stocks rallied after a few days of inconsistent price action later in the week – and I incurred modest losses on my Spyder hedge which I covered in premarket trading.

But more importantly I believe the Italian debt crisis is not an oddity – it lies at the epicenter of a world (private and public) immersed in debt as the global economic recovery ages. It is an example of the systemic financial problems and risks in Europe that have been swept under the rug – and that, over the intermediate term, should not be dismissed as a “one off.” This is particularly true if the ECB, as planned, moves away from a “money for nothing” policy.

Indeed as I remarked, while that Italian indigestion could elongate our domestic economic expansion – as the risk of a short term shock in higher inflation and interest rates abate – we should not lose sight that the synchronized economic expansion is growing more ambiguous and that the world, like never before, is flat and interconnected.

Mark Grant touches on this alternative view in is his commentary this morning:

I honestly believe that the markets, and most investors, do not understand exactly what is happening in Italy. Of course, the boys in Brussels, and Berlin, will claim that nothing of significance is happening, at all, in Italy, but then what else is new? I have the sense that these people understand, well enough, but they are following the time worn German playbook, “Deny, Deny and Deny.”

Mr. Salvini has stated, “As Italians, not as slaves of Berlin or Brussels.” It is a different time, as history echoes, once again, but I recall the rather famous words of Seneca the Younger (4 BCE-65 CE), “The master eats more than he can hold; his inordinate greed loads his distended belly, which has unlearned the belly’s function, and the digestion of all this food requires more ado than its ingestion. But the unhappy slaves may not move their lips for so much as a word. Any murmur is checked by a rod; not even involuntary sounds – a cough, a sneeze, a choke – are exempted from the lash. If a word breaks the silence the penalty is severe. Hungry and mute, they stand through the whole night.”

Mr. Salvini, rightly or wrongly, feels that Italy has been enslaved and he has bound with the Five Star Movement in his fight against the European Union. That much is clear to me. Did you expect him, in his first few days in office, to try to overthrow the European Masters? I believe that he, and the newly elected Italian government, have other tactics in mind. I also believe that they will begin to be effectuated in the not too distant future.

The New Yorker Magazine joins me in my contrarian corner. “Looking further ahead, however, there is great uncertainty surrounding not just Italy but the entire nineteen-nation eurozone. For the first time since it was formed, in 1999, the monetary union will be confronting a government in one of its core member countries that is implacably opposed to many of its rules and policies.” You see, I may hold the minority view on what is about to happen in the European Union, by way of Italy, but I am not totally alone in my sentiment.

The new government has a very distinctive policy agenda, which includes the establishment of a state-provided universal basic income. The League coalition also supports higher spending in various areas and it is also calling for a flat tax of fifteen per cent. Both parties want to roll back the quite unpopular pension reforms, that the E.U. regards as essential.

The E.U., it should be noted, doesn’t prohibit specific policies, but it does enforce broad fiscal targets that limit how much member countries can tax and spend. If the new government in Rome flouts these policies, Brussels will demand changes and most likely threaten it with fines. Brussels will shove, and Rome will shove back and that is when the real rebellion will occur, in my estimation.

Depending on how antagonistic the situation becomes, the European Central Bank could even threaten to withdraw its support for Italian government bonds, which it has been purchasing in large quantities, as part of its quantitative-easing program. The number is approximately $400 billion of Italian bonds, to date. One caveat of the ECB’s program is that any member government has to formally agree, in writing, to the policies and regulations of the European Union, before they will buy bonds and provide financial support. I just do not see the new Italian government signing up for what is going to be demanded.

I recall the words of Yanis Varoufakis, during the Greek crisis, “If you insist on policies that condemn whole populations to a combination of permanent stagnation and humiliation, you will soon have to deal not with Europeanist leftists like us but, instead, with anti-Europeanist xenophobes who see it as their vocation to disintegrate the European Union.” A decent prediction and a coming reality, in my view.

In any event, regardless of your personal view, what cannot be dismissed is that there is now a formidable amount of “risk” on the table for the European Union as it confronts the demands of the new Italian government. If you can honestly deny that, then you have been wooed by the political comments rolling out from Brussels and Berlin almost non-stop. “Do not be taken in,” I say, “because this is a very dangerous situation.”

Play the Great Game as you will but when I see Grant’s first ten rules, “Preservation of Capital,” under threat, then I am no longer willing to enter the arena. I am out of Italy. I am out Italian banks. I am out of European banks, in general, because of counterparty risks. I am also out of the European Union, as a general theme, because of the upcoming Italian revolt, which I believe will be taking place.

Spartacus has returned!

Bottom Line

Italy’s debt crisis isn’t a “one off.” It is symptomatic of the potential emerging risks – in an aging global recovery – in an increasingly flat world that is immersed in historically high debtloads (in both the private and public sectors).

2017 was a year of hope (and too little second level thinking) – that corporate tax reform would catalyze growth (and “trickle down”) – as multiples on the S&P Index expanded by three points. Wall Street prospered over Main Street.

2018 is a year of reality setting in (and too much first level thinking) – with a compression in price earnings ratios. With all the earnings excitement consider that stocks are basically flat for the year. Main Street is prospering over Wall Street.

The global expansion is aging. Note that employment, in particular, is a reliable indicator of a late economic cycle. (Consider the last time we were at 3.8% unemployment was April, 2000 – which marked the top and end of a 10 year “up” economic cycle). That was the lowest unemployment rate in a half a century, exactly the same unemployment rate (3.8%) that exists today.

While it “appears” that we are moving back to the upper end of a trading range, the market remains one without any memory – one that is dominated by products and strategies that frequently provide false signals.

Be skeptical of what the market is saying (over the near term), stay opportunistic, consider the emerging risks (which almost always appear when interest rates climb in a leveraged backdrop) and be flexible and impassioned in your trading — in the new regime of volatility that is upon us.


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Doug Kass

Doug Kass, since 2004 Doug Kass has served as President of Seabreeze Partners Management, Inc. He runs a hedge fund and individual managed accounts, co-authored “Citibank: The Ralph Nader Report” with Ralph Nader and the Center for the Study of Responsive Law in the 1970s and wrote "Doug Kass: A Life on the Street" two years ago (John Wiley). Since 2003 Mr. Kass served as a guest host on CNBC's "Squawk Box" and has guest hosted Bloomberg's "Market Surveillance" for the last five years. Along with Jim Cramer, Doug is the principal contributor to Real Money Pro.

2018/06/06
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