How To Invest In Spain
By some measures, Spain has emerged from the crisis in the Eurozone, and by others, it still has a long way to go. Spain gained global notoriety in the midst of the Euro crisis as the country’s debt ratios (debt to GDP) more than doubled from 40% in 2008 to around 90% in 2013 as the government decided to rescue the financial system with taxpayers money. The country was hard hit by economic recession and given its large size, Spain gained a “too big to fail” status. The precarious state of Spain’s debt was a key factor that pushed the European Central Bank (ECB) to initiate the first round of quantitative easing, whereby it bought government bonds issued by European nations. This action stabilized markets and economies and initiated a massive rally in Spain’s bond markets.
Fast forward: after implementing massive reforms, many of them very difficult labor market reforms, Spain is reaping the rewards in terms of higher economic growth rates, and a much improved current account balance with the rest of the world. The following chart shows how growth has surged; Spain has easily outpaced the rest of the European continent with a 3.2% rate in 2015. Despite recent positive trends, the labor market has suffered and the unemployment rate is still the highest in the Eurozone. While improving of late, overall unemployment is above 20%, and the rate among youths is still around 45%.
SPAIN’S GDP GROWTH RATES (%)
The long term Achilles heel of the Spanish macroeconomic environment remains the large fiscal deficit and high debt. Debt ratios are still high and likely to peak over 100% in the next two years. Despite warnings from the European Commission, Spain continues to miss its fiscal targets as regional governments under-deliver on promised spending cuts.
In the near term, the biggest problem facing Spain is politics. The country has no government in place, and various parties are working on forming coalitions by a May 3, 2016 deadline. Given the fractious nature of these parties, even should a coalition be formed in the coming months, there is a low likelihood that it could successfully govern / stick together for long thereafter. Each party has strong and contrasting opinions over important matters such as government budgets, labor reforms, and a Catalonia secession referendum. Despite the massive uncertainty over politics, however, Spain’s economy continues to perform pretty well.
In sum, from an investment climate perspective, Spain has some good trends in place but has significant risks lurking. For investors looking to access Spanish investments, the opportunity set lies in government bonds, equities, and corporate debt; Spain’s currency is the euro, and obviously not particular to Spain itself.
Spanish government debt currently does not offer an enticing combination of risk and reward, though risks are arguably contained by ongoing ECB monetary policy. In terms of reward, like many developed market government bond markets, the yields on Spanish bonds are extremely low. The chart below shows the evolution of the 10 year government bond; with yields in the 1.40% range, currently below the yield of the U.S. 10 year bond, these bonds are far from exciting. In fact, given the high debt load of the government and ongoing difficulties in controlling spending, these levels are arguably too low. However, they continue to be suppressed by monetary policy measures. As the ECB buys government bonds (including Spain’s), yields will remain low. Furthermore, regulatory measures have induced many financial institutions to pile into these bonds, depressing yields even more. While it may make sense for European financial institutions to continue buying and holding these fixed income instruments, it is hard to advocate to a global investor that the yield is compelling. Given the Spanish specific risks, it’s probably better to look at other alternatives within the European block.
