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Did the "Italy Selloff" Create any Bargains In U.S. Equities?

David Borun
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Did the "Italy Selloff" Create any Bargains In U.S. Equities?

Did the "Italy Selloff" Create any Bargains In U.S. Equities?

The U.S. equity markets declined for the third straight session on Tuesday, pushed lower by the deteriorating political situation in Italy and its effect on global asset pricing.  The Dow jones Industrial Average lost nearly 400 points, the S&P 500 finished the day down 1.2% and many individual stocks fell even more.  

Does widespread selling in U.S. equities (in response to a disruption that hasn’t actually affected us here yet) create an opportunity for investors to scoop up stock that have been undeservedly sold off?  Let’s take a look at the assets involved in Tuesday’s action to determine who might actually benefit.

The announcement that Italy would hold a runoff election this fall that will include two affiliated far-right anti-euro parties roiled world markets. At stake is the possibility that Italy’s citizens could vote in a government that badly wants to leave the European Union. Investors heavily sold Italian bonds, with the yield on 2-year debt climbing to 2.73% from just 0.48% on Friday.  U.S. treasuries moved in the opposite direction, with buyers looking for safe haven and pushing the interest rate on 10-year treasuries down to 2.82%.  The U.S. dollar rallied against the Euro. Oil continued its recent slide, closing at the lowest level in 4 weeks.

The prospect of economic turmoil in Europe is likely to keep the U.S. Federal Reserve acting more conservatively in raising short term interest rates for fear of over-shooting and stifling growth.

Broad selling of equities in Europe spread to the U.S. markets and many stocks with little to no Italian exposure declined sharply on the day.

Giant U.S. Supplier

WW Grainger (GWW) is the largest U.S. supplier of industrial-grade supplies and safety products.  Its products – everything from janitorial supplies to tools and parts to industrial equipment - is delivered to businesses of all sizes though its own extensive distribution network.  

Grainger is coming off a string of earnings beats, most recently posting $4.18/share in Q1, considerably higher than the Zacks Consensus Estimate of $3.41/share. Full year 2018 earnings are now expected to be $14.90/share, 30% higher than 2017. GWW is a Zacks Rank #1 (Strong Buy).

Grainger shares declined $6.90 or over 2% on Tuesday in the broad market selloff, though because it derives over 80% of revenues in the U.S. and Canada, it is relatively immune to the Italian problems and the stronger dollar. Low interest rates and fuel costs will actually help the company rather than hurting it.  Tuesday’s price action makes the stock an even better buy than before.

Banking on Volatility

Goldman Sachs (GS) was battered along with the rest of the financial sector, declining $7.98, a whopping 3.4%.  Fears of an economic crisis in Italy and the possibility of serious recession there had investors scrambling to dump shares of international financial institutions with potential exposure.

In reality, the chances of Italy actually leaving the European Union are still so low that this reaction is likely overdone. Investors learned a costly lesson about the inter-connectedness of large financial institutions during the crisis of 2008-2009 and are now hyper-sensitive to the possibility of cascading effects of asset repricing.

In reality, Goldman Sachs tends to earn more during periods of market volatility.  Their core trading businesses are likely to benefit from European uncertainty.

Regional Banks Punished

In the rush to sell bank stocks, smaller regional banks declined along with giant multi-nationals, even though the regional banks have little to no exposure to Italian assets.

In reality, it’s an excellent environment for these institutions as congress voted last week to repeal some of the more onerous conditions of the Dodd-Frank bill as they apply to smaller institutions.

Fifth Third Bancorp (FITB) has been a strong performer lately, coming off 16 consecutive quarters of exceeding earnings estimates, but the stock is more than 12% off its all-time highs – set earlier this month – including a 3% decline on Tuesday.  

With increasing revenues, steadily improving credit quality and a strong capital position, FITB is expected to earn $2.46/share in 2018.  Thirteen analyst upgrades in the past 60 days earn Fifth Third a Zacks Rank #1 (Strong Buy).  The recent price decline has Fifth Third trading at a forward P/E ratio of just 13X, and is an opportunity to buy a very strong performer at a discount price.

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