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Southern stampede

20 March 2014 By Neil Unmack, Fiona Maharg-Bravo

The euro zone periphery trade is running out of gas. Investors keen on a recovery story have been piling into assets in Spain, Italy, Portugal and Greece for over 18 months now. But some periphery assets are looking expensive. Further gains need two tricky conditions to be satisfied.

The bull run dates back to August 2012 with Mario Draghi’s claim he would do whatever it took to preserve Europe’s currency union. This year, Italian and Portuguese equity indexes are up 10 and 14 percent. The emerging market rout has dented Spanish stocks, but Madrid’s IBEX 35 is still up 22 percent since Jan. 1. Greek bank Piraeus just sold 500 million euros of bonds at a yield of just 5 percent amid huge demand, while shares in Italian lenders have also strongly rebounded.

The confidence reflects the euro zone’s progress in addressing its problems. Banks are raising capital, funding costs have fallen, and the economy is emerging from recession. The exodus from peripheral assets during the financial crisis has not yet fully reversed, suggesting prices could rise further. Global equity funds allocated 1.4 percent of their assets to Spain in January, still down from 1.8 percent in 2008, according to EPFR data. Some assets still seem good value in historical terms. Italian stocks trade on a forward multiple of 13 times next year’s earnings, according to Datastream, below their 20-year average. 

But that is not universal across the euro zone. Spanish stocks are trading at 14 times forward earnings, with Portuguese equities on an 18 times forward multiple – high historically and relative to British and German shares. Spain’s bailed-out Bankia trades at some 1.6 times book value according to Starmine. U.S. banks, which earn twice Bankia’s return on equity, are at 1.2 times.

For the rally in peripheral assets to continue, the euro zone needs to do more than pull out of crisis. First, politicians will have to push further reforms, particularly laggards France and Italy, which account for 38 percent of the region’s economy. Second, companies will have to start delivering on earnings: the return on equity of peripheral stocks is at a 20-year low relative to the core, says Morgan Stanley. Both are risky bets.


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