After two unsuccessful attempts to form a new Spanish government, this week marks a critical juncture in the race to form a new coalition before voters will be required to head back to the polls for what might be the third vote in a year. Despite the lack of governmental cohesion, the economy has seen its performance surprisingly improve in the absence of an elected government for nearly 9-straight months. Across the board the economy is showing strong signs of rebounding between falling unemployment, accelerating GDP growth, and inflation which is gradually climbing back into positive territory. Most of the gains have been driven by spending despite the constant pressure from the European Commission. However, despite the gains, the one area that has not benefited from the latest uptick in economic activity is the Spanish IBEX 35 equity index.

Economy and Stocks Diverge

Although for the most part stocks and stock indices are considered leading indicators of economic activity, for Spain, a divergence of epic proportions is currently underway. Following many years of depressed growth, the economy is posting its best results in years which has surprisingly coincided with the Spanish IBEX 35 reaching its lowest point since 2013 back in June. Although the stock benchmark is on the rebound, it still remains under substantial pressure after a disappointing -15.34% return over the last 52-weeks. Meanwhile, despite not having an elected government in place for since last December, the Spanish economy is largely feeling the benefits of more accommodation from the European Central Bank as deflation winds down, from a low of -1.10% reached earlier in the year to its current standing at -0.10%.

Helping to end the deflation has been strengthening consumer spending which is trending just shy of its pre-financial crisis highs. According to the most recent data, retail sales in Spain have risen by 4.90% on an annualized basis, helping growth to pick up to the fastest pace among any Euro Area peers, printing at 3.20% year over year. However, high consumption ignores the fact that Spain still has the second highest unemployment rate in the Euro Area after Greece, even after falling to 20.00% which marks the lowest levels since 2010. Should a governing coalition actually be formed, greater fiscal stimulus measures could help ease the high jobless burden, spurring greater growth in the economy. While progress is certainly being made even without a functional government, the one area that continues to struggle is the private sector.

One of the benefits of increased central bank accommodation has been the improvement in inflation and borrowing conditions across the Euro Area.  However, one of the less discussed implications is the havoc negative interest rates can wreak on the banking sector. Spain’s banking problems were more swiftly fixed that many other regions like Italy after the bailout back in 2012, but they are nevertheless remain under pressure, especially as net interest margins remain low. With almost all banks showing negative returns over the last 52-weeks, this has been the primary drag on the IBEX 35, with no immediate rebound anticipated. Although they are able to better serve the economy now that they are more solvent than in past years, there still are lingering concerns that will keep a lid on IBEX 35 upside over the medium-term, especially if other Euro Area banks face renewed scrutiny from investors.

Technically Speaking

Looking at the IBEX 35 chart, it appears that the index is at a potential turning point after recovering from multi-year lows reached back in June.   After rising above the downward trending 50-day moving average, the next major level on the upside remains resistance at 8745 which coincides with the 200-day moving average.  With the moving average also acting as resistance and prices currently consolidating within an ascending triangle formation, any move above this resistance level could signal a breakout and more bullish momentum over the near-term.  However, should the IBEX 35 fail to breakout from the range to the upside, a break of the near-term upward trend line paves the way for a retest of June lows a move toward 7500, especially if the 50-day moving average is broken to the downside.

Looking Ahead

Should the Spanish economy continue to make progress towards solving underlying structural issues like unemployment while keep growth stable and raising inflation, the outlook for the economy may be among the brightest in the Euro Area.  However, with banks remaining a lingering concern for the outlook, the IBEX 35 may not follow the economy’s lead, keeping the benchmark equity index under pressure for the foreseeable future, especially in light of the monetary policy backdrop.  Looking ahead, the banking sector will continue to play a critical role in any momentum in down the road for the IBEX 35.  While political deadlock might not appear like a stabilizing force for Spain, the economy has proven otherwise even though the economic recovery has not been accompanied by upside in equities.