Premature to bet on Spanish, Italian stock markets, says Barclays’ Gardiner
The pricing of Spanish and Italian markets overall may look attractive, but investors need to beware the heavy weight of certain sectors, and the dangers they still face, for example Financials, argues Kevin Gardiner, head of Investment Strategy, EMEA at Barclays.
Spanish and Italian stocks look like an attractive opportunity at first glance, with so much bad news seemingly priced in. But while we still see plenty of value in investing in aggregate European indices, where greater sectoral and regional diversification should allow investors a more balanced bet on the region’s equities, it’s still too early to take on the more concentrated individual European equity markets and the financials sector.
Following sharp falls during the second half of 2011, the Spanish and Italian equity markets have unsurprisingly underperformed the wider Europe ex UK index this year: by nearly 25% in the case of Spain and by 9% in the case of Italy, using MSCI indices. This is despite a 15-20% rebound in both indices over the past month, prompted by increased expectations over new measures set to be announced by the ECB in September. These declines leave Italian and Spanish equities trading comfortably below their longer-term average valuations. Forward P/E ratios for the MSCI Spain and MSCI Italy indices are currently below 9x and 8x respectively.
Nevertheless, Spanish and Italian stocks are clearly not for the faint hearted in the current climate. If the worst case scenario in Europe can be avoided, we see long-term value. Indeed, if the Germans and the ECB could pull a rabbit out of a hat, Spanish and Italian equities, which have been sold heavily, could see bigger confidence-related bounces than other markets. But until Europe can find some resolution to the crisis, sentiment will be the main driver.
Also, investors should consider the make-up of the indices of smaller equity markets, like Spain and Italy, before investing in them. They are usually made up of a smaller number of stocks than the aggregate indices, which means the index is very concentrated around a few names or sectors. For example, in Spain, where the market is dominated by financials and telecommunications, Banco Santander and Telefonica together make up nearly half of the index. In Italy, the energy and financial sectors account for over 60%, with ENI alone worth 25%.
Therefore, investing solely in these indices equates to placing a large bet on the very uncertain prospects of a few large companies. In Italy and Spain’s case, an investor would need considerable conviction on European financials – a sector which we are currently reluctant to take a strong view on, given how many unknowns there are.
This is why – with many European financials remaining some way away from being able to fund operations without the help of the ECB – we do not hold any strong convictions on the individual European equity markets, instead preferring to focus on Europe (excluding the UK) as a whole.