The European sovereign debt crisis has evolved into something resembling a persistent case of athlete’s foot. Just about the time you think it’s cleared up, you get that nagging itch again.
Just weeks after the event that we had all feared—the sovereign default by Greece—came and went with barely a stir from the capital markets, Europe is again emerging as a preoccupation for investors.
This time it is Spain in the news. Immediately after taking office, Mariano Rajoy, Spain’s new prime minister, rattled the markets by announcing that Spain would not meet its deficit reduction targets for 2012. And this was even after enacting the harshest austerity measures since the Franco era.
With Spain’s unemployment rate now over 23% and its economy looking to join those of Ireland and Portugal in sinking back into recession, it should come as no surprise that Spanish bond yields are rising (see chart). At 5.3%, the Spanish 10-year bond is now above the psychologically important 5% mark.
Source: Bloomberg
Still, it’s important to keep a little perspective here. Though they are higher than they were a month ago, Spanish yields are still well below the crisis highs of 2011. And importantly, the rest of the Eurozone remains quiet. There is no talk at this time of “contagion,” and European equities remain in a multi-month bull market. In fact, Spain’s market is the only European major bourse to not see positive returns in the first quarter.
For all of the wailing and gnashing of teeth in the financial press, I do not see Europe as being at risk of another 2011-style panic. To start, now that investors have seen what a sovereign default looks like, the mystique is gone. We’ve been there and done that, and the world didn’t stop spinning.
Furthermore, another sovereign default is unlikely at this time. European policymakers have made a clear distinction between countries that are basically solvent but illiquid—such as Spain and Italy—and those that are fundamentally insolvent and incapable of ever paying back their debts—such as Greece. If the European Central Bank’s open market operations prove to be insufficient in maintaining confidence, we may see Spanish yields continue to rise in the short term pending more aggressive action. But I would view this as little more than the natural ebb and flow of investor sentiment and not as a sign of impending doom.
Investors no doubt remember that 2011, like this year, started out with a great first quarter before falling into a trap of on again / off again volatility for the remainder of the year.
Could this happen again in 2012? Perhaps. But investors should also remember that the periodic bouts of volatility last year proved to be fantastic buying opportunities.
I continue to view European equities in general and Spanish equities in particular as an attractive contrarian value play; Spanish stocks enjoy some of the cheapest pricing and highest dividend yields in the world at current levels, and many Spanish companies—including long-time Sizemore Investment Letter recommendation Telefonica (NYSE:$TEF)—get a large percentage of their revenues from outside of Spain.
The iShares MSCI Spain ETF (NYSE:$EWP) is the easiest way to get access to the Spanish market. At current levels, the ETF is priced at 9 times the earnings of its constituent companies and yields 9%.
Disclosures: TEF and EWP are held by Sizemore Capital Clients
