After a Bella Run, Italy ETF May Not be Done

Amid all the headlines detailing significant fiscal woes in the eurozone's peripheral countries, the iShares MSCI Italy Index Fund EWI has been a solid performer over the past year. The lone ETF devoted to the eurozone's third-largest economy was up nearly 14 percent over the past 12 months before the start of trading Wednesday. Not too shabby for a country mired in a recession and one often dubbed as the next shoe to drop after Greece and Spain. On the other hand, EWI's risk-adjusted returns are not that impressive. In the past 12 months, EWI has essentially performed in line with the S&P 500. While U.S. GDP growth is not setting the world on fire, it is superior to Italy's. The U.S. is not officially in a recession. Italy is. And for the pleasure of dealing with those factors, investors get an ETF in EWI that has a beta of over two against the S&P 500. Combine dour macro factors with the risks that come along with owning EWI and it would appear that there are more compelling ways to play an ongoing rebound in European equities. However, there is another side to the story. iShares Global Chief Investment Strategist Russ Koesterich upgraded his view of Italy to Neutral from Underweight, saying that the concerning outlook for Italy's economy may already be priced into the country's stocks. "While Italy's growth outlook remains dire, prices of Italian shares already reflect this," said Koesterich in a note. The good news as it pertains to Italian equities comes by way of the bond market. Italian 10-year sovereigns yielded north of six percent for much of July and August, according to Bloomberg data, but that yield has collapsed to about 4.2 percent today, indicating the country's borrowing costs are falling. "Despite the short-term pain inflicted on the economy by difficult reforms, the reforms have made a big difference in restoring Italy's credibility and competitiveness," said Koesterich. "Thanks to the country's fiscal reform and the European Central Bank's bond buying commitment, Italy's borrowing costs have fallen significantly over the past six months." Adding to the EWI dichotomy is the ETF's sector composition. Financials account for over 30 percent of the fund's weight and with European banks seemingly constantly ensconced in controversy, that sector allocation could be problematic for conservative investors. On the other hand, EWI is arguably a stealth high oil price play because the energy sector receives an allocation of almost 31 percent and Eni SpA E alone accounts for almost 23 percent of EWI's weight. Then there is the 10.4 percent weight to industrials, which may be even more problematic than the ETF's bank exposure. Italy's November industrial orders slipped 0.5 percent while industrial output for that month fell one percent. The economy there is expected to contract one percent this year. Adding to the near-term risk for EWI is that Italy, arguably one of the least politically stable developed market nations, holds elections in February. On the bright side, investors do not have to pay a premium for taking a flier on EWI. The ETF's P/E ratio is 12.59 and its price-to-book ratio is just 1.25. That means EWI is cheaper than the iShares MSCI Germany Index Fund EWG, among others. Curiously, those others include the iShares MSCI Spain Index Fund EWP, which could be perceived as even riskier than EWI. For more on ETFs, click here.