Spain's Election: Re-Evaluate Ibex

| About: iShares MSCI (EWP)

Summary

The elections in Spain have produced a fractured parliament, favoring the reformists.

The Brexit vote led to a sell off in peripheral, and particularly Spanish indices.

The elections should, particularly once a government is formed, reassure investors.

When Britain voted to exit the European Union, it was not their markets that went into free fall, it was Europe, or more particularly the peripheral economies of the south. The FTSE 100 (UKX) fell 3.15%, the DAX 6.82% , and the IBEX index fell 12.35%. Clearly, markets were compounding the fear of the possibilities of a nation state invoking article 50 of the Lisbon treaty with renewed economic malaise in the Eurozone.

It definitely did not help that Spain had elections this weekend that seemed to show a rising far left party gaining in the polls. The consequences of this would have been grave: a leftist government in Madrid (a podemos-PSOE pact) that would have overthrown the last ally that Merkel had in the Mediterranean. She would be facing a unified anti-austerity south and a Brexit at the same time.

However, the results of the elections must give everyone pause. Should a reformist government remain in power, there is significant upside to Spanish indices, and ETFs that track them such as: the iShares MSCI Spain Capped ETF (NYSEARCA:EWP), the iShares Currency Hedged MSCI Spain ETF (NYSEARCA:HEWP), the Deutsche X-trackers MSCI Spain Hedged Equity ETF (NYSEARCA:DBSP), and the SPDR MSCI Spain Quality Mix ETF (NYSEARCA:QESP). According to El Pais, the seats won by each party are:

Partido popular (conservatives) 137
PSOE (socialist) 85
Podemos (far-left) 71
Ciudadanos (centrists) 32
Other 25
Click to enlarge

The socialists and the far left have campaigned on an anti-Austerity platform that promised to undo many of the reforms of the Rajoy government. For a time, they looked like they would be able to form a government. They still may by making a pact with the regional parties, but their position has weakened significantly since December. The interesting thing to watch would be any hint of resignation of the socialist leader, Pedro Sanchez, or a call for new leadership within his party. The socialists are key to almost any new government. They can try to make a pact with the left like they tried to do 6 months ago, or they can make a "grand coalition" with the conservatives.

Ciudadanos has been, since its inception, a reformist party. However, it has shown itself to make deals with the far-left podemos party. They seem to be willing to make a deal with any party to form a government.

The conservative people's party has been the party that has steered Spain through the last four years of austerity and reforms. I would not say that they are an ideal party or that their ideology is perfect, but Rajoy has been a staunch ally of Merkel and he has made difficult reforms in the face of great opposition at home. What investors need to watch for is the People's Party remaining in some form of coalition government to continue with reforms and remaining an ally of Merkel. They are the party whose position has improved the most since the December elections and hold the senate with an ample majority, which would allow them to make constitutional changes should they be necessary as well.

When Britain voted for Brexit, capital fled the Spanish indices. Should a reformist government take office, the reforms that have been implemented over the last four years would mostly be preserved and new reforms would be undertaken, improving the performance of the Spanish economy and giving the European Union one less (very big) problem to deal with.

This should lead to a return of capital to Spain and upside for the Spanish indices. With the results that have given the conservative and reformist parties a considerable advantage in negotiating a coalition government, I am cautiously optimistic on Spain and I will become bullish if and when a reformist government passes the investiture vote.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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.