Spain is really going through the wringer. The next few days could be make-or-break time for the country.
The country’s Ibex index (equivalent to our FTSE 100) fell by nearly 4% yesterday as investors fret over political turmoil in the country. The cost to the Spanish government of borrowing money over ten years rose back above 6%.
That’s the highest level since Mario Draghi’s grand promise to save the euro was made earlier this month. Clearly, investors are getting sick of waiting for Spain to ask for help.
So is this the final crisis that breaks the eurozone?
In short – we suspect not. In fact, I’d use this burst of panic as an opportunity to buy on the dips. Here’s why.
Spain’s woes are very real – but they’re not a ‘game-changer’
Europe is back in the headlines. This time it’s Spain that’s in trouble.
Over the next 48 hours, an independent audit of the Spanish banking sector is set to be revealed. It’s likely to show that the banks are short of around €60bn.
Meanwhile, prime minister Mariano Rajoy has to announce budget plans for next year. That’s not going to be fun. The markets want to see more economic reform. Voters are not so keen – there have been street protests in Madrid, with violent clashes between riot police and demonstrators.
Just to make things even more complicated. Rajoy also has to deal with the news that Catalonia has called snap elections. The regional president, Artur Mas, now wants independence from Spain. So if he’s re-elected, this is effectively a vote by Catalans for independence from Madrid.
It’s all very grim – no wonder Spanish bond yields have leapt. So why won’t Spain give the European Central Bank (ECB) the go-ahead to buy its bonds?
The trouble is that if Spain wants help, it has to ask for it, and accept conditions in return. The last thing Rajoy wants right now is to pull out the begging bowl and go to the ECB for a bail-out. Particularly if it forces him to impose politically unpopular reforms.
It seems that markets might have to force the issue once again, by driving bond yields to unsustainable levels.
This is all becoming very familiar. As the FT puts it, “the eurozone has failed to break out of the ‘crisis, complacency, return-of-crisis’ merry-go-round that has characterised the past three years”.
The point is, we’ve been here before. And – without wanting to sound too complacent – we’ll get back to the ‘complacency’ phase again too. Which is why now looks a good time to buy.
The bullish case for eurozone stocks
The bullish case for eurozone stocks is not based on the underlying economies being healthy, or indeed anywhere near healthy. For me, there are two main factors.
The first is valuation. As we noted back in early summer, eurozone stock markets were hitting levels at which, over the long run, you could expect to make double-digit annual returns.
At that sort of valuation, stocks are pricing in a significant amount of pain. So things don’t need to get better, as such, for markets to rise – they just need to stop getting worse.
Markets have bounced quite a way since then – particularly the hardest-hit, such as Greece. But they still look worth buying for the long run.
The second factor is the ‘don’t fight the Fed’ factor. The biggest worry for the eurozone all along has been the fear that the authorities would allow someone important to go bust. Effectively, what’s rattled the markets has been the notion that another Lehman Brothers might happen in Europe.
Now, my own views on bail-outs are that we might well have been in a better position by now if we’d allowed more bankruptcies back in 2008 and 2009. But that’s not relevant. As an investor you have to deal with things as they are, rather than as you think they should be.
Back in 2009, when US and UK markets were crashing, the thing that saved them was the recognition that the entire financial system wasn’t going to collapse. The Bank of England and the Federal Reserve made it very clear that they would do what it took to prevent any more important institutions from going bust.
With that recognition, investors decided that while things might be bad, they weren’t facing the apocalypse. Once the ‘end-of-the-world’ discount was removed, markets rebounded.
It increasingly looks as though the same thing is happening in Europe. The European Central Bank has embraced the path of money-printing. It’s already said that it is ready to buy Spanish bonds. Rajoy just has to give the word.
He might give it today, he might not. But sooner or later he has to. If he doesn’t, Spanish borrowing costs will rise to the point where somebody is forced to do something. The point is that the worst-case scenario outcome – a complete implosion of the eurozone – looks increasingly unlikely.
That’s why I’m happy to continue drip-feeding money into European markets. For my own part, I’ve focused on Italy as I think it’s fundamentally in better shape than Spain or Greece.
Although clearly with hindsight, I wish I’d bought the other two this summer as well.
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