- Economic growth was 1.4% in 2014, but this year it is expected to be more than 3%
- Economic difficulties in Latin America are a problem for Spanish equities but the worst is over for the economies in Latin America
- The outlook for corporate earnings will strengthen as the economy improves further
- “All in all, investors should not be too worried by the occasional political storm, but should focus on the country’s sunny fundamentals. Spain can do it,” concludes Cornelissen
Spain is in recovery mode, but has not been rewarded for this by equity investors so far in 2015. “The Spanish economy is doing fine and there is a strong cyclical recovery underway.” That is how Robeco’s Chief Economist Léon Cornelissen sums up the current state of the fourth-largest economy in the Eurozone. The country is emerging from a difficult period as a result of the global financial crisis. Economic growth was 1.4% in 2014, but this year it is expected to be more than 3%.
Despite the positive growth figure for 2015, the Spanish stock market is lagging: The IBEX 35 Index has risen 7% this year, while the Euro Stoxx 50 Index is up 11% (as of 5 June 2015). “Economic difficulties in Latin America are a problem for Spanish equities,” explains Cornelissen. “And investors, who already expected a strong economic recovery last year, have now become more cautious.”
Opportunities in equities
Despite the investor pessimism, Cornelissen sees opportunities in Spanish equities. “I am moderately optimistic about the rest of the year for two reasons. First, the worst is over for the economies in Latin America. Interest rates in Brazil will fall in 2016, which will stimulate the economy.” Latin America is an important destination for exports and many Spanish companies are active in this region.
“Second, the outlook for corporate earnings will strengthen as the economy improves further,” he continues. “Financials, which represent the biggest component in the IBEX 35 Index, are geared to see an earnings improvement. And the banks have successfully recapitalized by issuing new shares. Moreover, Spanish house prices have risen again, which is very important for mortgage loans.”
Debt levels improve
The recovery will lead to improved public finance figures, says Cornelissen. “The figures are not great; a 4.5% government deficit is still too high, as is the current debt-to-GDP ratio of just under 100%. But the direction is positive and the government expects these figures to come down. I agree with the government, given the strong economic recovery. The deficit is expected to go down to the 3% threshold set by the Stability and Growth Pact of the EU.”
Another important factor behind this Spanish renaissance is the country’s increased competitiveness, says Cornelissen. “Spanish exports are doing well. Unit labor costs have come down, which enables companies to lower their costs. This has been helped by labor market reforms, especially a decentralization of wage negotiations. Currently Spain has the strongest growth within the Eurozone.”
Outlook on bonds more subdued
He is less optimistic about bonds, because a lot of the good news has already been priced into the market. Government bond yields have gone down over the last two years and are now around 2.2%. “The ECB’s bond buying is set to support Spanish government bonds,” says Cornelissen.
“And ECB President Mario Draghi will continue the program until September 2016, which will keep the lid on any strong rise in interest rates. In addition, Spanish credit worthiness will improve as a result of economic growth. That said, I expect the impact on credit spreads versus German government bonds to be small. These spreads are already low and I do not expect them to tighten much further.”
Elections not a concern
Another major theme for the financial markets in 2015 is the national elections. These have to be held before 20 December and are expected to take place at the end of October or in November. Regional elections were held in May and saw the rise of two new political parties: Podemos and Ciudadanos. Podemos (which means ‘We can’) is often compared with Syriza in Greece, while Ciudadanos (which means ‘Citizens’) is liberal and moderate.
Another looming question is Catalan demands for independence. Because of the size of its economy, this region is vital for Spain. Therefore, any talk of secession is a risk to the financial markets. However, Cornelissen is not really worried, and even sees bright spots ahead, once the traditional two-party system has come to an end. “In theory, a Podemos victory is a risk to Spain’s membership of the Eurozone, and any steps towards a Catalan secession could also spook the markets. But it is not going to happen soon. Podemos has peaked in the opinion polls, so I do not fear a situation similar to that of Greece occurring in Spain.”
“The rise of Ciudadanos can be seen as a boon to investors because the party opposes Catalan independence – it forms a useful counterweight to regional nationalism,“ he adds. “All in all, investors should not be too worried by the occasional political storm, but should focus on the country’s sunny fundamentals. Spain can do it,” concludes Cornelissen.