Spain Is Failing; What Is An Investor To Do?

by: Plan B Economics

The European debt crisis is creeping back into the news. This time Spain is taking the spotlight.

"After three months that were calmer than expected, the euro crisis is back," said Holger Schmieding, chief economist at Berenberg Bank in London. "The speed of the recent surge in yields has elements of a renewed market panic."

On Friday, April 13th, 2012, Spanish 10 year bond yields approached 6% and Spanish stocks continued to get slammed. Between December 7, 2007 and April 13, 2012 the iShares MSCI Spain Index ETF (EWP) is down 61.42%. The ETF is down 47.77% from its post-Lehman high, reached November 13, 2009.

While this crisis is resurfacing onto the mainstream media publications, it has been at the top of some investors' minds for years. Unfortunately, even the most bearish of forecasts are proving to be tame.

According to a new report by Carmel Asset Management, Spain's debt-to-GDP ratio may be 50% higher than the headline numbers; Spain's true debt-to-GDP figure may be 90%. Also according to the report, Spain's real estate market will fall another 35%, hitting the country's zombie (i.e. undercapitalized) banks. Spain is in for some pain.

Unfortunately, so are the rest of us.

The Spanish economy is almost 5 times larger than the Greek economy. Do you remember the market turmoil caused by seemingly insignificant Greece? It was bad.

Luckily, the world managed to cobble together the funds to keep the Greek crisis from bringing everything down. Spain, on the other hand, may not be savable. Of the money that has already been theoretically 'committed' to saving the European project, only a portion has been allocated. Will Germans and/or the IMF have the willpower to send more gobs of money into the European toilet to save Spain? I doubt it.

What Is An Investor To Do?

Although I wouldn't recommend this strategy, investors willing to take on a lot of risk might consider shorting a number of Spanish equities. The reason I don't recommend this is because of the asymmetric risk-return profile of short-sales - while profit is limited, losses are unlimited. Short selling is something only professional investors should attempt.

Instead of profiting from the downside, an investor could wait for a bottom and try to catch the eventual recovery.

The following three Spanish stocks (listed in the U.S.), which include two zombie banks, have already been beaten down, but could fall even further as the crisis progresses. Consider following these stocks until the coming Spanish crisis peaks, at which point they may be a bargain (if the companies still exist):

Ticker Company 1yr Return
(BBVA) Banco Bilbao Vizcaya Argentaria, S.A. -40.95%
(STD) Banco Santander, S.A. -40.24%
(TEF) Telefonica, S.A. -37.48%

All of these companies are currently trading below book value, but investors mustn't get sucked into a value trap. These stocks could get even cheaper as the Spanish debt crisis unfolds:

Ticker P/B Dividend Yield Payout Ratio Operating Margin Profit Margin
BBVA 0.65 8.24% 38.42% 27.46% 23.42%
STD 0.51 12.79% 36.44% 28.84% 21.07%
TEF 0.78 14.36% 126.82% 16.02% 9.85%

Waiting for a market bottom is nice in theory, but what does an investor do between now and then? Until the Spanish crisis peaks, there will probably be market turmoil. And those that cannot gain access to 10-year credit default swaps on Spanish debt need a plan.

Investors should speak to their financial advisor to see what fits with their objectives and risk tolerance. A short term tactical solution an investor might discuss is the classic three-pronged approach to 'safe haven' investing:

  1. Cash
  2. US Treasuries (TLT)
  3. Gold (GLD)

To many, cash is a no-brainer as a short-term allocation. However, an inflationary response to a financial crisis - as we've seen in the past - could erode its real value. Cash is a big drain on real wealth over the long-run, so allocations are usually only maintained for a short amount of time, depending on the investor's need for liquidity. Another concern with cash (assuming it is kept on deposit at a bank) is the relative stability of the bank and government that guarantees the bank's deposits. Even if the cash deposit is fully guaranteed, in the event of bank insolvency it could take months before a depositor can access it.

US Treasuries have proven themselves as safe havens, despite persistent US budget deficit issues. While the US has its own problems, it remains the global reserve currency and continues to act as the global flight to quality. However, with nominal yields near all-time lows I don't see US Treasuries as a long-term investment.

Gold is a bit trickier. While it could benefit from the fear of financial collapse and the resulting monetary response, it could also be damaged by US dollar appreciation, which could rise with a flight to safety. Investors seeking gold exposure somewhere between paper gold certificates and physical bullion might want to consider ETFS Physical Swiss Gold Shares ETF (SGOL) or ETFS Asian Gold Trust ETF (AGOL). I personally have a long-term, strategic allocation to gold and will maintain that position until real interest rates become persistently positive.

For many investors, there might be a case to tactically allocate a portion of a portfolio across all three prongs, if they believe markets are about to get more volatile.

Disclosure: I am long SGOL.

Additional disclosure: Data source: Finviz. This is not advice. While Plan B Economics makes every effort to provide high quality information, the information is not guaranteed to be accurate and should not be relied on. Investing involves risk and you could lose all your money. Consult a professional advisor before making any investing decisions.