You need a cool head and steady nerves to invest in Italian stocks: They are as volatile as Emerging European indexes. According to Morningstar data, over the past five years, the Morningstar Italy Index’s standard deviation was close to 20%. Only Greece, Turkey, Russia, Hungary, and Poland did worse than Italy.
Over the same period, the volatility of the eurozone index was 14.31%, with France and Nordic countries among the closest to the mean. To find less volatile markets, you need to look outside the eurozone, in Switzerland or in the United Kingdom.
From a global perspective, the five-year standard deviation of the Italian benchmark is similar to that of China and Peru and slightly higher than South Africa and Thailand.
Poor Performance
Despite its higher volatility, the Morningstar Italy Index did not perform better than other, less volatile markets. From 2011 to August 2016, the Morningstar Italy Index returned 5.12% annualised compared with the 10.49% annualised total return of the Morningstar Eurozone Index. In spite of that, the Italian benchmark’s performance was still ahead of the other PIGS countries; Portugal, Italy, Greece and Spain.
To explain the underperformance of Italian stocks relative to the eurozone, we have to look at the index’s basket. In recent years, the Morningstar Italy Index has been penalised by its large exposure to financials and energy sectors. A weak macroeconomic environment, the high amount of non-performing loans, a hefty exposure to Italian government bonds, as well as efficiency and profitability issues, all weighed on the banking sector, while the energy sector was affected by the collapse in oil prices as well as the resurgence of geopolitical risks.
Indeed, Italy has had a hard time in the past five years. After spiking in May 2011, the Morningstar Italy Index lost 36.5% in the following months, touching its low one year later, at the end of May 2012. In 2011 and 2012, investors shed risky assets on fears of contagion of the Greek crisis, the threat of political instability, and lack of economic growth. The Italian index is very skewed towards cyclical stocks and has a heavy underweighting, relative to its European peers, in the defensive ones.
As such, it is generally more vulnerable during bear markets. In fact, pharmaceutical and defensive consumer goods companies weigh just 3% of the index.
2008: the Turning Point
Looking at the Italian index’s volatility levels, 2008 represents a turning point. Following the collapse of Lehman Brothers, market volatility soared worldwide, and, as far as Italy is concerned, it never returned to its 2004 heights. Compared with other eurozone countries, such as France and Germany, volatility remained high even in 2013-14, because the benefits of the European Central Bank’s actions were delayed and did not immediately exert their full effect on peripheral countries.
Moreover, the financial crisis increased stocks’ correlation: They were sold off regardless of sectors or fundamentals.
Volatility and Risk
Investors should remember that there is a difference between volatility and risk. For investors, risk is ultimately a permanent loss of capital rather than volatility itself. "Volatility can be seen as an opportunity, especially for those who invest for the long term," says Francesco Paganelli, analyst at Morningstar.
"It tends to rise when markets dive and valuations start becoming more attractive. Even if a higher volatility requires cool head and steady nerves, it’s generally also the best time for investors with a long-term perspective to find the best investment opportunities.”
