Spanish political risk, the bond market… and the rugby world cup
Spain’s election this year may spur its bonds to underperform further against those of Italy, according to Hinesh Patel, portfolio manager at Old Mutual Global Investors
The odds of Italy winning this year’s Rugby World Cup are 500/1, according to bookies. Spain, another so-called “peripheral” member of the eurozone, hasn’t qualified for a tournament since 1999 – when it lost all three games. So however minuscule Italy’s chances of victory, they are infinitely larger than those of Spain.
In the field of economics, Spain has experienced a promising recovery. Business and consumer confidence have rebounded to decade-highs from the depths of the debt crisis; unemployment has begun falling, real-estate values appear to be nearing a floor and exports have been performing strongly. Considering the euro area as a whole grew only 1.2% year-on-year, Spain’s 3% year-on-year expansion is stellar. So stellar, it has displaced Ireland as the poster-child of how painful reforms and adjustments can lead to (eventual) recovery.
But this shouldn’t really come as a surprise. The government has been running persistently large budget deficits, approaching 5% of GDP for 2015. And who is been plugging the gap? Foreigners. The Spanish government bond market is now more than 50% owned by “non-residents.” This raises the spectre of capital flight quickening with every negative headline ahead of the general election in December, even as polls show a decline in support for parties of the extreme left – assuming you believe pollsters. Remember, these politicians have touted restructuring the national debt.
Spain’s major export partners are struggling, meanwhile, which to us means the budget deficit may yet balloon further.
To be clear: Italy, or its government debt market at least, does not present a long-term investment opportunity. In addition to horrible demographics, weak productivity and highly levered corporates, the country has a laughably inefficient bureaucracy. And like in Spain, youth unemployment is unacceptably high while credit growth is non-existent at best. But crucially, Prime Minister Matteo Renzi’s administration has a strong mandate to push through structural reforms. So for the medium-term, this provides confidence that there is a willingness to honour debts.
As such, we are positioning within the Old Mutual Global Strategic Bond Fund for Spanish government bonds to continue underperforming comparable Italian securities. Both countries have the ability to pay their debts, as well as a potential backstop in the European Central Bank. Yet just as their rugby squads merit different treatment by punters, their relative bond-market liquidity and willingness to pay down debt deserve much greater attention by investors.