Despite recent growth the Italian stock market still lags behind the rest of Europe, but analysts believe it will catch up in the next few months.
Marco Nascimbeni, an equity broker at Merrill Lynch in Milan, is bullish because of government welfare reforms that will reduce the public sector borrowing requirement and reinforce optimism about Italy's EMU prospects: While it is difficult to imagine Italian stocks going up if the rest go down, there is a good chance of the market overperforming."
Alfredo Granata, head of research at Banca di Roma in Rome, agrees. "We lagged other markets in 1996 and only began to catch up this year and we expect a similarly good performance for the rest of this year."
Granata is optimistic partly because of the recent stock market privatisation accompanied by regulatory reform which he believes has increased foreign investors' trust in the market.
Turning to the economy, Granata says: "The last figures for GDP show that the economic sluggishness has bottomed out." He expects growth and profits to improve in the next two quarters. He also believes that short-term rates will continue to converge on the Bund, further improving the financial situation for domestic companies.
Hugo Doyle, an economist with Banca Commerciale Italiana in London, says Italy's bond markets are strictly connected to EMU. "We have a positive view on Italy joining EMU at the outset."
Doyle says the alternative is a complete delay rather than Italy being left outside the core, with the figures showing Italy is on course to bring its deficit under 3% of GDP.
Doyle adds: "Even if the Bundesbank increases rates we think that Italy will benefit from the convergence of rates at the short end of the curve with some leeway to tighten the spread. The yield curve, particularly the short end, will benefit when welfare reform and the 1998 budget are finalised."
Nascimbeni's choice of sectors is influenced by the new pensions law: insurance and banking. "It is important to note that private pension funds have not existed up till now, so there is a new institutional investor in the market. There is confidence despite the fact that we will not see much liquidity from funds for two or three years."
Granata, while advising foreign investors to track the index, also recommends the Italian financial sector, which is in the midst of restructuring to meet competition from elsewhere in Europe. He is also positive on energy, while generally favouring companies that have been privatised or are due for privatisation, such as ENEL.
Nascimbeni adds: "The telecommuication sector - one of the most followed in-ternationally - is only composed of Telecom Italia and its mobile phone subsidiary TIM but we make very strong buy recommendations for both.
"We are optimistic about the privatisation process for Telecom Italia, which will help the stock to perform well."
Among other stocks, Merrill Lynch recommends Montedison as a buy, has cumulative recommendations on Fiat, Generali and INA, and is neutal with a positive long-term outlook on ENI, the oil company.
The main risk for Granata is a Wall Street correction, with some limited worries about interest rates elsewhere in Europe. "If I put together the domestic and the international outlooks I remain optimistic," he adds.
For Nascimbeni, the major risks surround EMU. "Italy could suffer from a postponement or risk of postponement. There is always domestic political risk and has been for 40 years. But at the moment things look fine, though politics is something investors should always have their eye on.""