EWI: Italian Stocks Are Positioned For Momentum

The iShares MSCI Italy ETF (NYSEARCA:EWI) presents an interesting prospect to research analysts and investors alike. The exchange-traded fund ("ETF") has gained by nearly 45% in the past twelve months amid support from Italy's endogenous macroeconomic factors. Moreover, the ETF holds exposure to a few high-quality companies, providing it with an advantage during a trying time for global financial markets.

Although EWI has performed strongly in recent times, we need to remind ourselves that the stock market is cyclical. As such, we thought it might be prudent to assess and discuss EWI's prospects after its strong year-over-year gains.

Here are a few factors to consider.

Positives

Many European markets are suffering from inverted yield curves amid recessionary fears and high levels of government bond supply, leading to depleted stock valuations. However, if the world's economic challenges are considered, one might have to conclude that Italy's moderately upward-sloping yield curve is admirable.

For those unaware, the yield curve illustrates the market's anticipation of short-term interest rates. Moreover, the financial markets typically use the yield curve as a reference for future economic growth, and a moderately upward-sloping yield curve is deemed desirable. A moderate curve concurrently results in lower market risk premiums and higher stock valuations.

Another interesting fact about Italy's financial markets is the limited credit risk. As displayed in the diagram below, Italy's 5-year CDS values have tapered significantly in the past year, suggesting lower credit risk spreads, which might allow risky assets such as stocks to gain value.

Although these values are retrospective, Italy's latest inflation and GDP numbers suggest a prolonged trend might realize.

Let's drift away from our economic analysis and into the ETF's portfolio.

According to EWI's fund fact sheet, the ETF has a turnover ratio of 14%, meaning its average portfolio position lasts approximately seven months, give or take. With less than 30 holdings in its portfolio, we think frequent rebalancing is a good way to maintain the fund's investment thesis.

As things stand, the iShares MSCI Italy ETF has a value-centric style, with a bias towards medium market capitalization securities. We believe value stocks could be winners in the coming years due to the "higher for longer" interest rate outlook, which theoretically supports value stocks.

Furthermore, we encourage investors to consider the ETF's risk profile. The ETF's medium-capitalization exposure contributes to a high beta coefficient (1.11), which is compelling to risk-seeking investors but might be discouraging to risk-averse investors.

A glance at EWI's sector exposure shows an intense focus on the financial sector and durable goods, with utilities and industrials close behind. The vehicle's procyclical exposure is conducive to a market characterized by low credit risk and a healthy bond market, which is why we are bullish about the ETF's systemic risk exposure.

An additional attraction to the iShares MSCI Italy ETF is its valuation metrics. As mentioned before, EWI has a value-centric investment approach, which is reflected by its price-to-earnings and price-to-book multiples.

The ETF's P/B multiple is at a 3.81x discount to the SPDR® S&P 500 ETF Trust (SPY), while its P/E ratio is at a 2.3x discount. Although the Italian and U.S. markets are exposed to different economic environments, a relative comparison holds validity as both the U.S. and Italy are developed markets.

Lastly, the iShares MSCI Italy ETF might be an attractive proposition to income-seeking investors as the ETF's dividend yield of 3.48% is compelling. For comparison, the SPY has a dividend yield of 1.45%, with the worst historical dividend growth rates.

Risk Factors

Most risk factors that we identified pertain to the risk-return attribution and portfolio management of the ETF.

Firstly, EWI possesses a negative information ratio. The information ratio reveals a portfolio manager's skill by measuring a portfolio's excess return (over benchmark) versus its excess risk (over benchmark). As such, the ETF's negative IR indicates underwhelming risk-adjusted returns.

Furthermore, the iShares MSCI Italy ETF's Sharpe Ratio is slightly subdued, especially when compared to the SPY. Thus, suggesting underwhelming volatility-adjusted returns.

An additional risk factor worth considering is Italy's slowing economic growth. The country's trend growth has slowed considerably in the last decade amid structural struggles among the European Union's main constituents.

Long-term stock returns tend to coalesce with nominal GDP growth, which is worrisome to investors with long-term regional exposure.

Final Word

Our analysis shows that the iShares MSCI Italy ETF is still in good shape after solid year-on-year returns. Despite possessing both structural and systemic risks, the ETF is exposed to a market driven by favorable risk premiums. Furthermore, the ETF shows signs of value and has a desirable dividend profile.

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