Despite a third quarter return to growth in the 16-country euro zone, Spain’s economy has continued to contract as fallout from the collapse of the nation’s construction industry continues to wreak havoc on unemployment rates and equity prices. The road to recovery got a bit rockier on Wednesday, as Standard & Poor’s lowered its ratings outlook on Spain to negative, noting the likelihood of “significantly lower” financial growth and “persistently high fiscal deficits relative to peers over the medium term.” The move falls short of an actual downgrade, but news of the revised outlook sent Spanish stocks and bonds sharply lower.
The yield premium that investors demanded for holding 10-year Spanish government debt rose to 70 basis points above German government debt, the low-risk European benchmark, an increase of about 10 basis points over Tuesday. Spanish equities also plummeted, with the IBEX-35 blue-chip index sliding 2.3%.
S&P indicated that a full-blown downgrade could follow within two years if government actions to reduce a fiscal deficit prove unsuccessful. If the government announces concrete fiscal measures that we believe could credibly achieve annual primary surpluses of 2% or higher by the end of the forecast period in 2012, downward pressure on the ratings may abate,” said analyst Trevor Cullinan.
The Spanish government’s most recent 2010 budget includes a series of tax increases aimed at reducing the country’s deficit to 8.1% of GDP next year, a reduction from the 10% level expected at the end of 2009. The executive arm of the European Union has given Spain until 2013 to bring the deficit below the 3% level mandated by EU rules.
Spain ETF: Exposure To The “Real Spain”?
The iShares MSCI Spain Index Fund (EWP) lost 1.4% on Wednesday following the news, but is still up more than 30% year-to-date in 2009. Given the turmoil in the Spanish economy this year, EWP seems to have performed surprisingly well. The explanation for this apparent contradiction lies in the actual composition of the Spain ETF. Almost 45% of EWP’s holdings are allocated to two multinational firms, Banco Santander and Telefonica SA, that generate the majority of revenue and earnings outside of their home country. As of September 30, the smallest stock in the index underlying EWP has a market capitalization of about $3 billion, while the median for all components was nearly $8 billion.
As such, EWP doesn’t offer complete exposure to the Spanish economy, but rather to 30 mega-cap companies that are headquartered there. So while unemployment has surged to nearly 20% (and youth unemployment has closed in on a staggering 40%), EWP has delivered relatively solid returns, as increases in South American revenues at Santander and Telefonica have boosted share prices (for more looks “under the hood” of popular ETFs, sign up for our free ETF newsletter).
The SPDR DB International Government Inflation-Protected Bond ETF (WIP), which invests in inflation-linked government bonds from emerging and developed economies, has significant exposure to western Europe debt, but zero to Spain. WIP finished Wednesday flat.
Disclosure: No positions at time of writing.