Italy Considers Leaving the EU

In this episode of Market Foolery, host Chris Hill talks with investor-at-large Tim Hanson about a few of the market’s biggest stories — especially the economic situation in Italy today. Tune in to get some context behind Italy’s potential exit from the EU, what its withdrawal from the EU could mean for banking, how today’s bonds issue will affect Italian banks, and more.

Also, Dick’s Sporting Goods (NYSE: DKS) is up a whopping 23% this morning on a better-than-expected quarter. The World Cup will present some fun [and expensive] opportunities for sports retailers like Nike (NYSE: NKE), Adidas, and Under Armour (NYSE: UA) (NYSE: UAA). The German team’s strategy looks like it might give them a nice advantage in this year’s World Cup. Tune in to find out more.

A full transcript follows the video.

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This video was recorded on May 30, 2018.

Chris Hill: It’s Wednesday, May 30th. Welcome to Market Foolery. I’m Chris Hill. What people don’t know about Fool Global headquarters is that, on the roof of this building, we have our own version of the bat signal. And when there’s economic trouble in Europe, I go up to the roof and I turn on the bat signal, and then Tim Hanson shows up in the studio to explain what in the world is going on. Tim Hanson is joining me here.

Tim Hanson: [laughs] I’m not sure I ever do a good job of explaining what’s going on, because I’m not sure I know. But, thank you! I’m glad to be the go-to source when there’s calamity in Europe!

Hill: [laughs] Not general calamity, economic calamity. We’re going to talk about that. We’re also going to get to sporting goods, which is becoming a more interesting industry for investors. We’ll get to that. Let’s start, though, with Italy. Long-time listeners of this podcast —

Hanson: Of which there are … ?

Hill: Dozens.

Hanson: Dozens? [laughs]

Hill: I mean, I was actually thinking about this this morning. We started doing Market Foolery in 2011. And there were a good number of times those first couple of years where we were talking a lot about Greece. Obviously, a couple of years ago, it was Brexit.

Hanson: We did a couple of episodes on Spanish unemployment, when it was up at 25-28%. Those were good ones.

Hill: [laughs] Well, I mean, not for the —

Hanson: It’s down to 16% now in Spain!

Hill: — unemployed in Spain, but in terms of a topic of conversation for this podcast, sure. Yesterday, Italian bonds had their worst day basically ever. Now, I don’t own Italian bonds —

Hanson: Congratulations!

Hill: — [laughs] so, it was less of a concern for me. But, this is the headline, that, because of political upheaval, Italy may in fact be considering leaving the E.U. in the way that Great Britain had their vote a couple of years ago. When you look at this situation, I guess, one of my top two or three questions is, how big a danger is this for investors in the United States who, like me, don’t own Italian bonds? Is this something that’s just sort of, that’s over there, and that’s not really going to affect my investments? Or, is there a danger?

Hanson: It depends. It depends on how it plays out. What’s interesting, I think, about the situation in Italy now vis-à-vis what we saw in Greece a few years ago, is that in some ways, it’s more of a political challenge than it is an economic challenge. The blueprint is there for how to bail out a country that’s struggling with a debt burden. The ECB has brought that force to bear when it comes to repurchasing bonds and keeping interest rates low.

What’s interesting about this in Italy is that, what happened was, the president has prevented a coalition government from a right-left coalition, the Five Star Movement and the League, who are both opposed to European integration, from taking office and from appointing a euro-skeptic as the Finance Minister, pretty much spitting in the eye of Italian voters and saying, “No, no, we don’t care what you think, voting democracy. We’re just going to keep our technocrats in charge, and it’ll be cool.”

They’re going to have to have another election. Every time they’ve had these elections, the number of people voting for the Five Star Movement and voting for the League has increased. So, I don’t know what they think they’re going to get on the other side to keep this together. Ultimately, if that government decides that they want to try to pull out of the E.U. in the same way that Britain voted to, it poses a real challenge for the European Union at that point, because what happens to those bonds? If you pull out of the E.U., you no longer use euros, so they would get redenominated in Italian new lira, or they might get defaulted on — this is a really long-winded answer, by the way.

Hill: It’s not a simple situation, that’s fine.

Hanson: [laughs] In that case, the bonds are probably worth a lot less than their face value. In the event that the bonds are worth a lot less than their face value, then all the banks in Europe and some in the United States who hold those bonds as capital on their balance sheets all the sudden have big holes blown in their balance sheets. And then you’re back at a banking crisis. What happens in a banking crisis? Equity is used to shore up the balance sheet, which means stockholders lose a lot of money. If you have exposure to global indexes, if you own shares of banks that have exposure to Italians bonds, if it just sets off general contagion in the financial system, those would all be scenarios that would have negative effects for U.S. investors.

Hill: OK, so, I don’t own Italian bonds, but I do have an S&P 500 Index Fund, which has some U.S. banks in there, and they probably have some level of exposure.

Hanson: Probably. I mean, good luck explaining a large U.S. bank balance sheet. I mean, they’ll probably all deny they own Italian bonds, but they probably have something on there.

Hill: You’re saying, if I call up Brian Moynihan at Bank of America or Jamie Dimon and just say, “Guys, just level with me and all other investors, what’s your exposure to Italian bonds?” they’re not necessarily —

Hanson: They’d have to make a couple of phone calls to probably figure out the gross exposure. I mean, the banks that are screwed are the Italian banks themselves, because they own a ton of Italian bonds. And they’re all trading at fractions of book value right now. The big ones are like 0.3X book, which is really cheap relative to the global banking multiple average.

I saw a couple of articles yesterday making the claim that now is the time to be buying Italian banks, because this is more of a political crisis than it is an economic crisis. It’ll get sorted out. The bonds won’t go bad. The banks will be worth, maybe still less than book, but not so much less than book, and you’ll double your money. I don’t know. I don’t know. It’s hard. I mean, populism’s not going away. Populism has had a nice 10-year run. [laughs]

Hill: Yes, and as we look at any kind of trend, whether it’s an economic trend, or, in the case of Italian politics, a voting trend, as you said, for the technocrats who are currently in power, where do you think the next election is going to go, and what do you think that’s going to do to your power base?

Hanson: I think the other question, which we’ve been asking for years, is what is the point of the European Union? Is it integration or is it not? Because this half-integration, three-quarters-integration, that they’re trying to pursue doesn’t seem to be working out that well for people. For example, you’re in the European Union, but there is no such thing as a European Union bond.

Hill: That seems odd.

Hanson: There are Greek bonds, and there are German bonds, but the Germans don’t want to commingle their bonds with the Greek bonds. And you can understand why the Germans don’t want to do that —

Hill: “Our bonds are just fine.”

Hanson: — because German bonds are more creditworthy, they carry lower interest rates, so on and so forth, and they don’t want to be on the hook for bailing out the Greeks or the Italians or the Spanish. But, if you don’t want to be on the hook for helping your compatriots when they’re in trouble, why are you compatriots? It’s an open question. I know, obviously, there are benefits to European Union integration in terms of ease of travel, more commerce trade, so on and so forth. But, some of these important (unclear 8:08) issues still haven’t been solved 25 years later.

Hill: Alright, let’s move on, closer to home, some earnings from Dick’s Sporting Goods. First quarter profits, higher than expected. They raised guidance. Shares of Dick’s Sporting Goods up 23% this morning.

Hanson: Bam.

Hill: Don’t call it a comeback, they’ve been here for years. Wow!

Hanson: [laughs] Still, the two-year chart is not so kind.

Hill: Yes, that’s true. Although, one of the things I find interesting about this is, it’s obviously a different company, but it seems like what’s happening with Dick’s Sporting Goods rhymes with what happened last week with Foot Locker.

Hanson: What happened at Foot Locker? I didn’t see that.

Hill: Basically, a smaller version of this. Slightly better than expected. In the case of both of those retailers, I have to believe that if you’re Nike and Adidas and Under Armour, part of you is rooting for them to do well. When Sports Authority went under, for all the talk of, “Nike is really building up their e-commerce,” and they are, but they didn’t build it up to the point where Sports Authority goes out of business and Nike doesn’t miss a beat because their e-commerce platform is so strong. No, Nike had to have a writedown because of the inventory that they had in Sports Authority. So did, by the way, Under Armour, as every Under Armour shareholder, like me, is painfully aware of.

Hanson: You know, better to write that stuff down than try to pretend that it’s not imperiled, which a lot of companies do. This is an interesting report. Dick’s was down 50% over the last few years. Expectations were pretty diminished around the stock because of the move to online commerce, they’d had some margin erosion. They’d additionally announced, I think it was in February, that they weren’t going to be selling assault rifles anymore, which I know people thought was going to have a negative effect on their sales, so the stock was pretty heavily shorted.

And they came back with a report that it was OK, and it beat expectations, and they raised their expectations for the year. I think the people who were shorting the stock are getting out. You’re probably seeing what’s called a short squeeze, where a lot of people who are getting hit hard on their leveraged short positions are trying to buy those back, and that’s causing the stock to go up in a very pronounced matter.

But, ultimately for Dick’s, it’s a tough business for those sporting goods stores, as it is for a lot of bricks and mortar retail operations who need to compete with not only the Amazons of the world, but with their vendors, the Nikes, Under Armours, and Adidases, all going direct-to-consumer, as well.

Hill: You mentioned, the two-year chart for Dick’s Sporting Goods, not so good. Similarly with Under Armour, the two-year chart, not very good. Although, the last six months, Under Armour has started to bounce back. It’s up about 50%. Now, that’s obviously off of a pretty ugly low, but that seems like it’s bouncing back. And, if they can have, at least operationally, another six months like they’ve had over the past six months, and if Kevin Plank can manage to keep his executive team around him for, I don’t know, let’s just call it the entire calendar year, [laughs] that seems like that would also be a win.

This comes right as we are gearing up for the World Cup. I saw this morning that, before the World Cup has even been played — 32 teams in the World Cup — Adidas has already claimed a small victory over Nike because Adidas is outfitting 12 of the nations in the World Cup. Nike is outfitting ten.

Before we get to the World Cup proper, it seems like this is both an opportunity and a challenge for these types of companies. Obviously, it’s great exposure, lesser for Under Armour, but much more so for Adidas and Nike, it’s great exposure opportunities. It’s also a marketing spend. They’re almost always spending more money, and sometimes it pays off, and sometimes it doesn’t. And I’m wondering if you have any strong feelings about the timing of big global sporting events, whether it’s the world cup or the Olympics and companies like Nike and Adidas.

Hanson: Well, they definitely get a bump from them. You definitely see sales increase. When the last World Cup was held, jersey sales contributed to meaningful growth in Europe at a time when the European economy was struggling. You could see that show up in Nike’s and Adidas’ results.

I mean, I think they’re good opportunities. I think the company that benefits the most is going to be the one where, if you get to sponsor the team that wins it, those fans all like to get the new kit. But, as an investor, you have to make sure to remember when those events happened, so that when you’re analyzing companies, you make apples to apples comparisons. You don’t want to forget it was a World Cup year and then panic the next year when sales are down.

Hill: [laughs] Yes, exactly. I was looking at the odds. I don’t know, United States —

Hanson: Not in it. Not in the World Cup. It’s disappointing.

Hill: Based on the site I was looking at this morning, it looks like Brazil and Germany are the co-favorites right now in the betting world, followed by Spain and France and then Argentina, Belgium, England.

Hanson: Germany is a good team. They’re fun to watch. They have a lot of depth. They do a high-pressing style, gegenpressing, which is actually the style of defense I teach my seven-year-old boys’ team. Relentless pressure on the ball.

Hill: [laughs] Do you differentiate the type of pressing?

Hanson: I did send out a somewhat obscure translated German-language article to the parents on the team explaining what we were going to be doing this year. It’s worked out pretty well.

Hill: Wait, hold on. What was the response to that email?

Hanson: There was no response. At risk of deviating on a tangent —

Hill: Over-communicate.

Hanson: My main goal in coaching the kids team is to not deal with any meddling, troublesome parents. The master plan behind sending out an article like that — I also do a lot of juggling with the ball at the first practice, as the kids are showing up — is to pretty much demonstrate that I know significantly more than any of you about what we’re doing here, so don’t even talk to me. Just don’t talk to me. And it works! Nobody responded to the email! Nobody argued with it, nobody suggested I do something else during the games.

Hill: I like that, good strategy.

Hanson: But, Germany has the depth. So, it was an interesting (unclear 15:05) the World Cup that a lot of the World Cup teams, they don’t get to practice together a lot. It’s going to be hot. They’ve already played long club seasons, so most of the teams are probably going to be playing a more drop-back style of absorbing pressure and then trying to counter-attack, whereas Germany has the depth to play this more relentless pressuring attack, which could be an advantage for them.

Brazil obviously has a lot of wonderful individual contributors. I would say, the dark horse there is Belgium. If they’re going to make a run, this is the year, because they have Lukaku and Kevin De Bruyne, I like him. This is their golden generation. If they’re going to do it, this is the year to do it. So, they’ll be motivated, I suspect.

Hill: As I mentioned yesterday, we are off tomorrow. It’s a short week for us because we have FoolFest, which is our two-day investing event here in Alexandria. We’re going to be back on Monday. And, again, it gives you a great chance to check out other Motley Fool podcasts if you haven’t already, like Industry Focus, like David Gardner’s Rule Breaker Investing, Motley Fool Answers. You can find them anywhere you find podcasts. You’re presenting at FoolFest.

Hanson: Yep!

Hill: Give me a sneak preview of coming attractions. What are you going to be talking about?

Hanson: We’ll be presenting the methodology and some of the early findings around some additional work we’re doing to create Fool stock indexes. Right now, we have The Fool 100, which is out and live in the world and being published. Then, we’re currently working on something we call Total Fool, which is, like the total stock market index, a representation of all the stocks The Fool likes, regardless of market cap, industry, so on and so forth. And once we have Total Fool all ready to go, we can break Total Fool up into Fool Small Cap or Fool Biotech or Fool Growth. They’re little sub-indices off the big mother index.

We’ll be presenting to people who are interested about the methodology we’re using to go about creating Total Fool, where we’ve set thresholds for inclusion, how we do rebalancing. A lot of the data we get comes out of our Fool IQ database. We’ve done a lot of work figuring out why things move around in that database between being high conviction or not high conviction, can we set those thresholds in such a way that we maintain all the performance and get lower turnover, so on and so forth. It’s a little bit of a wonky presentation, but hopefully people will find it interesting and a little bit fun.

Hill: Within The Fool 100 Index, what’s the exposure to Italian bonds?

Hanson: I’ll have to make a couple of phone calls about that. Probably limited, because we’re mostly technology and consumer, not a lot of financials.

Hill: Tim Hanson, thanks for being here!

Hanson: Thank you, sir!

Hill: As always, people on the program may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don’t buy or sell stocks based solely on what you hear. That’s going to do it for this edition of Market Foolery. The show is mixed by Austin Morgan. I’m Chris Hill. Thanks for listening! We’ll see you on Monday!

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Chris Hill owns shares of Amazon, Under Armour (A Shares), and Under Armour (C Shares). Tim Hanson owns shares of Amazon. The Motley Fool owns shares of and recommends Amazon, Nike, Under Armour (A Shares), and Under Armour (C Shares). The Motley Fool has a disclosure policy.

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