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Equity Research

Is the underperformance of Spain’s stock market coming to an end?

In recent years, Spain’s stock market has registered underperformance in Europe due to, among other factors, the country’s lack of significant differential premium growth vs. other member states.

Madrid - ES

In addition, technical factors deriving from index profiles (IBEX 35 is heavily concentrated in the financials industry, which has been greatly burdened by a context of low interest rates, capital requirements and technological disruption) and a rising political-risk premium (chiefly due to Catalonia and risks stemming from governmental composition). All of which is within the context of considerable re-rating of the technology industry (without excessive specific weighting in Spain) and very poor perception of LatAm (the region accounts for c.20% of earnings of Spain-based companies and is the source of the greater part of their internationalisation process). As a result, Spain’s relative level of per capita income bottomed in 2021, with a discount of c.30% to the average for EU member states (a far cry from the minimum gap of c.15% vs. Europe in 2008, and returning to record levels of 2000).

Leading economic indicators are starting to reflect potential reversal of this situation. In fact, the IBEX35 has registered outperformance in the region year to date (+c.1% vs. –c.11% Euro Stoxx 50).

In our opinion, the present circumstances suggest that we may see further outperformance in the coming years because the market in Spain may fare relatively better than others for investors seeking shelter in the current scenario of inflation. This conclusion is based on several factors: Firstly, because of Spain’s brighter prospects regarding growth of GDP (+c.3% p.a. during 2022–24 vs. +c.2% on average for EU members), owing to its relatively low bar for comparison (Spain was hit harder by the pandemic, as observed in the correlation between number of deaths and decline of GDP), the recovery of its tourism sector (which accounts for c.15% of GDP) and the impact of Next Generation funds (impact of c.100bp on estimated growth of GDP during 2022–24 vs. +c.50bp in average for Europe).

Secondly, we are seeing collateral effects of Russia’s invasion of Ukraine on the price of certain commodities in a context of fragmentation of manufacturing processes, and the fact that this is benefitting LatAm, which appears to be facing prospects of becoming a new global manufacturing hub. In this regard, the indicators show that the region’s main economies are accelerating, probably because they are faring better at this stage of the cycle from the effects of reopening (LatAm is the last region to lift restrictions, as it was the last to be shut down by the pandemic). In addition, in recent quarters, we have seen signs of easing of the FX crisis that has emerged in recent years (compounding the region’s structural problem of bloated USD-denominated debt) and that has wreaked havoc on the cash generation of Spain-based companies that are exposed to the region. Furthermore, it must be noted that the region is a leading exporter of commodities, the high prices of which should underpin growth.

Thirdly, a context of rising interest rates (all other economic variables remaining equal) favours recovery of the banking sector (the financial industry has a weighting of c.26% on the IBEX35), and high energy prices at this time stand to favour earnings momentum in the energy and utilities industries (combined weighting of c.30% on IBEX35).

Lastly, Russia’s invasion of Ukraine has spurred the growing perception of a pressing need for energy independence in Europe. In this regard, we think Spain holds all the cards to emerge as the leader of this energy transition, in view of its considerable potential to develop renewable energies (PV, wind, hydro, etc.), its unique natural capital and a suitably sized/managed/positioned industry. Renewable energies in Spain now account for c.1% of the country’s GDP and are registering rates of growth in excess of c.10% (in 2021, surpassed only by Germany in terms of installed capacity).

Summing up, we are seeing the first signs of what may be a (long) period of outperformance of Spain’s economy vs. other EU members as a result of a relatively low bar for comparison (starting levels), solid positioning to hedge inflation-related impact, improvement of conditions in LatAm and leadership of the energy-transition process in Europe.

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