Spain's Strong Economic Growth Held Back By Banking, But Not For Long
Watch out Europe, Spain, once considered a troubled economic region mired deep in debt and unemployment, has become a relative powerhouse. While many economic indicators, most specifically unit labor costs, have led to relative prosperity, one indicator of economic prosperity lags: its stock market remains stagnant, an institutional multi-asset research piece from Source points out. However, this could change because the sector holding back stock prices is likely to get a lift.
Spain
Spain, once the "problem child," has reduced its unit labor costs and economic numbers are robust
"The problem child that was Spain has turned into the dynamo of Europe, with growth far outstripping rivals," the research piece, titled "The Spanish enigma," points out. Monitoring specific health barometers such as manufacturing PMI, a "robust" 53.6 in July, industrial production that was up 4.5 percent as of June and a 17 percent increase in housing transactions is highlighting economic signs of life. Even the nagging issue, unemployment, is showing signs of improvement. While still above 20 percent, the number of job seekers fell by 347,000 year over year basis July 2015. A trend is in place, it appears.
This all translates into higher general economic activity, as measured by Gross Domestic Product, which was up 1 percent in the second quarter. In fact the 3.1 percent year-over-year GDP gain in Spain was only bested by the headline economic performer in the region, Ireland.
How Spain overcame the economic malaise
Spain’s problems in overcoming the recession hurdle of 2008-2009 were exacerbated by several factors the report, authored by Paul Jackson, head of research, Andras Vig, research associate, were multifold. Looking back at the current account trade deficit, which reached 10 percent of GDP by 2008, the loss of competitiveness is apparent. The productivity of the Spanish worker, measured by unit labor costs rose by 40 percent while German labor costs remained flat.
With a common currency between Spain and Germany there was now "natural" method to balance out economic activity that a lowered Spanish currency would have solved.
"This loss of competitiveness compounded the balance of payments problem caused by an overheating economy fueled by inappropriately low real interest rates set by the ECB in Frankfurt," the report noted. Spain’s "road to redemption" was brought about in notable fashion by a decline in unit labor costs. This was accomplished through high unemployment – up near 26 percent at one point – as well as government measures to make labor more flexible.
The result? Unit labor costs in Spain have been dropping while labor costs throughout the region have been on the rise. Once the highest labor cost among the four primary economic powers in the region, Spain is now approaching a labor cost similar to that of France after eclipsing Italy. Germany seems to be marching to its own productivity beat and is nearly ten percent lower in cost than Spain and France, making their export costs less expensive and thus more attractive.
Asset prices tell the story of Spain’s recovery – with the exception of the stock market
The primary method to benchmark’s Spain’s economic recovery, the report noted, is to see progress based on the relative value of ten year interest rates. What was at one point a 600 basis point higher ten year note in mid-2012 has now reverted to a 120 bps spread now.
While interest rates reflect less concern and risk in the sovereign nation, the Spanish stock market, measured by the IBEX equity index, only outperformed the Eurostoxx 50 during this period 79 to 63 percent. The stock market disparity is even worse when one considers recent performance, as the IBEX is up 11 percent over the last year while the Eurostoxx50 is up 21 percent and the German DAX index is up 28 percent. (The headline unemployment number still stands near 20 percent, a figure not analyzed to great length in the report.)
What is holding back Spain and its stock market from advancing on a relative value basis?
With economic strength generally abounding in the numbers out of Spain (with the exception of headline unemployment, which is trending lower) what is holding back the stock market?
The report first looks at political considerations. The big question in the region is: will the Greek political plague spread to other regions in Europe. Greece’s Syrzia party – promising the equivalent of a chicken in every pot – appears to have been stopped at its northern borders. Citing opinion polls, the Source report says it is unlikely that Podemos, the Spanish version of the Syriza party, is likely to gain any more than 70 seats in parliament and is unlikely to form a government that could challenge the EU status quo.
With politics not a reason for Spanish stocks to be held back, the problem is with the banks, the report says. And this is set to change. "The fact that mortgage loans were up 15% y-o-y in May in Spain could be good news – the economic revival is boosting bread and butter banking business," the report observed. Having a large banking sector, which was a problem for its stock market, could soon be an advantage. "Happily for investors in Spain, positive feedback loops between economies and banks will work in their favour."
Disclosure: None.