European Periphery Debt Overvalued

May.29.14 | About: iShares MSCI (EWI)

Summary

Bond yields in Italy, France, and Spain inconsistent with macro fundamentals.

Cause of disparity is misplaced hope in Mario Draghi's promises.

Opportunity in situation is shorting specific stock and bond markets in the region.

Ever since the peak of the European debt crisis in 2011, bond markets in Europe's periphery have rallied sharply. Credit spreads between ten-year Treasuries and bonds in Italy and Spain are less than 50 basis points, while yields have fallen in both countries by over 1% in the last twelve months.

This contradicts the reality of the countries' economic and financial situations. Debt/GDP ratios continue to rise in the eurozone and signs of recovery are limited at best. The main spark has been the promise of Mario Draghi to use the ECB printing press to keep borrowing costs down. He has yet to be tested on this promise, so the enthusiasm is misplaced.

The opportunity is in shorting bond and equity markets where there is the greatest misrepresentation of price versus macroeconomic fundamentals. The two countries that stand out to me are France (NYSEARCA:EWQ) and Italy (NYSEARCA:EWI). France currently has the weakest economic outlook amongst the European core with policy decisions that only worsen this trend, while Italy has the most overvalued bond market. Italy is only second to Greece in terms of the worst performing economy amongst OECD nations since 2000.

Disclosure: I am short EWQ, EWI. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.