More from my friend David Kotok:
Spain and Its Banks: Is It Time to Bottom-Fish?
June 25, 2012
This commentary was written by Bill Witherell, Cumberland’s Chief Global Economist. He joined Cumberland after years of experience at the OECD in Paris. His bio is found on Cumberland’s home page, www.cumber.com. He can be reached at Bill.Witherell@cumber.com.
Last week the Spanish government released reports on the results of “stress tests” applied to Spanish banks by two independent consulting firms. These indicated that Spanish banks will need between 16 and 62 billion euros of new capital. These amounts are well below the 100 billion euros European governments have agreed to provide to Spain to strengthen its banking system. The stress tests indicated that Spain’s three largest banks – Santander, BBVA, and Caixabank – will not need any outside help. These results do ease fears about Spain’s banking system and about Spain’s possible need for a large-scale bailout in the future. The European Central Bank (ECB) gave a further boost to Spanish and other euro-system banks by loosening collateral criteria, which will increase the availability of collateral for counterparties and thereby support the provision of credit to households and nonfinancial corporations. The greatly depressed Spanish bank stocks responded positively to these developments.
The future course for Spanish banks, however, is not assured. The four major global accounting firms – Deloitte, Price Waterhouse, Ernst & Young, and KPMG – will release by the end of July a detailed analysis of the loan portfolios of Spanish banks. This will be followed up by further, more detailed stress tests in September. Some analysts have complained that the recent stress test was not sufficiently adverse. And, as discussed below, Spanish banks are expected to continue for some time to operate in an economy deep in recession.
The single Spanish market ETF listed in the US, the iShares MSCI Spain Index Fund, EWP, tracks the MSCI Spain Index, covering 85% of the publically available total market capitalization of the Spanish equity market. Investors in this ETF should be aware of the great importance of the financial sector in this market, accounting for some 41.4% of the fund. This contrasts with the 18.4% average for the eurozone. The next largest sector, telecommunication services, accounts for only 18.2%. The largest individual holding is Banco Santander SA, accounting for 21.6%. Then, following Telefonica SA at 18.2%, the third largest holding is Banco Bilbao Viscaya Argenta at 11.0%. Thus the two largest banks alone account for approximately one third of the total Spanish equity market.
Investors also have to consider, of course, developments affecting the remaining 58.6% of the market, most importantly, the state of the Spanish economy. Recent developments have not been encouraging. Spain’s industrial production declined by 8.3% in the year through April. GDP is expected to decline by almost 2% on an annual basis this year and probably will register a further 0.7 drop next year. The jury is still out as to whether Spain will be able to cover its financing requirements going forward, with an economy mired in recession and committed to a stringent austerity program. Developments outside of Spain and at the eurozone governmental level will be important, as they will likely determine whether contagion of the crisis to Spain will ease or worsen. A positive sign is that the Spanish 10-year yield fell from the previous week’s very concerning highs of over 7% to close at 6.34% on Friday.
Spanish equities have been driven down severely by the crisis in Europe and the bursting of a construction and real estate bubble in Spain, a drop of over 24% year-to-date and of about 44% over the past 12 months. This compares with a decline of about 6% year-to-date and 30% over the past 12 months for the eurozone. Valuations have become relatively attractive. The average P/E ratio for the equity holdings in the Spain ETF, EWP, is 8, which compares with a P/E ratio of 10 for the eurozone ETF, iShares MSCI EMU Index Fund, EZU.
The MSCI Spain equity index is up 15.3% so far this month from a low reached at the end of May. Bottom-fishing in Spanish equities, particularly the equities of Spanish banks, appears to be already underway. This may be premature in view of the still unresolved risks to the eurosystem. Markets are still waiting for more effective actions by the European governments. We doubt they will be satisfied by the results of the upcoming eurozone heads-of-state meeting. We too are waiting for more convincing evidence that Europe is resolving its problems, before we add positions in Spain to our International and Global Multi-Asset Class portfolios.
Bill Witherell, Chief Global Economist
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