Must-know: Investing in Spain

Market Realist

Overview: A guide to investing in the PIIGS nations (Part 15 of 15)

(Continued from Part 14)

Investing in Spain

Investor confidence on Spain is increasing with a rating upgrade from Moody’s (MCO), Standard & Poor’s (MHFI), and Fitch. This shows increased investor confidence in the Spanish economy. Yields on the ten-year Spanish government bonds fell to 2.579% on June 9, 2014. This was lower than the 2.615% yield offered on the U.S. ten-year Treasury note on the same day. This was the first time, since the Eurozone tumbled into its debt crisis, that Spain’s yields went below the U.S. Treasury yields. However, some say that if you take exchange rate differentials into account, Spain may have still yielded more than the U.S. on June 9. The ten-year Spanish bond yielded 4.152% at the end of last year. It currently yields ~2.67%. The decrease in yield hints at increasing investor confidence in the economy.

Why have yields fallen so low in Spain?

Yields on Spanish bonds have fallen to record lows. There are two primary reasons for this:

  1. Following the European Central Bank’s (or ECB) mandate, European nations have effectively guaranteed payment—minimizing default risk. Bond investors demand higher interest rates when there’s a chance of default of interest or principal by the issuer.
  2. Sovereign debt markets are usually governed by the fear of inflation. This erodes the value of a bond’s interest payments. However, the European economy is currently so slow that the main fear is deflation—not inflation.

To contain inflation, the ECB may begin its own quantitative easing program. The ECB would buy bonds to keep interest rates low.

The iShares MSCI Spain Capped ETF (EWP) primarily invests in large and mid-cap Spanish stocks. Two of its top three financial holdings—Banco Santander SA (BCDRF) and Banco Bilbao Vizcaya Argentaria SA (BBVA)—account for 33.88% of its total assets. Sector-wise, financials dominate the fund. They hold 47.62% of total assets. The fund has returned 7.51%. It’s up 5.66% on a year-to-date (or YTD) basis.

Looking at the broader emerging market scenario, despite recent rising geopolitical tensions, stocks haven’t completely followed the typical “risk-off” script. A number of high-risk segments have performed relatively well. The simple reason is that investors have found a new interest in relative value. Read our Market Realist series, A key trend: Why relative value is trumping risk aversion to understand which market segments potentially offer this value.

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