Goldman Sachs Says Beware Europe Peripheral Stocks
European companies most dependent on revenue from Spain, Italy, Greece and Portugal are rising in the stock market at the fastest pace in five years, providing chances for short sellers after two earlier rallies fizzled.
Firms with sales from those countries surged 21 percent in the 15 weeks to Nov. 2 as European Central Bank President Mario Draghi pledged to preserve the euro, compared with an average 5.3 percent gain for exporters to the U.S., China and Europe’s strongest economies, Goldman Sachs Group Inc. indexes show. Similar rallies for companies serving so-called peripheral countries heralded losses of as much as 44 percent through November 2010 and July 2012, data compiled by Bloomberg show.
Bears say Enagas SA in Madrid and Rome-based Enel SpA (ENEL) will struggle as Spanish unemployment surges to a record, austerity measures push Italy into the biggest economic contraction in three years and Greece, which triggered the region’s debt crisis 2 1/2 years ago, risks breaking the terms of a European Union- led bailout. Bulls say valuations below historical averages make the shares too attractive to pass up as ECB support reduces the threat of a euro breakup.
“There is no real evidence that things have picked up,” Sharon Bell, an equity strategist at Goldman Sachs in London, said in a phone interview. “Political moves and also central banks’ moves have been supportive for these stocks. Although you can see these bouts of outperformance, the underlying economies are still weak, therefore earnings for the companies exposed are likely to remain weak.”
The Stoxx Europe 600 Index (SXXP) fell 1.7 percent to 270.27 last week, the most in a month, as the European Commission cut its euro-zone growth forecasts and investors focused on the U.S. budget debate following President Barack Obama’s re-election. The gauge has climbed 11 percent in 2012 as the ECB announced in September a plan to purchase bonds of countries that seek assistance to tackle rising borrowing costs. It dropped 0.3 percent to a two-week low at the close of trading today.
Greek Prime Minister Antonis Samaras won support of enough lawmakers last week to approve a package of austerity measures needed to unlock further EU financial aid. Even so, an EU official said euro-area finance ministers won’t decide to release 31.5 billion euros ($40 billion) of funds that have been frozen since June when they meet in Brussels today. The official spoke on Nov. 8 on condition of anonymity because the deliberations are private.
European stocks that had the biggest declines last year as the debt crisis spread have led gains since the end of July. Between July 20 and Nov. 2, a Goldman Sachs measure of companies reliant on peripheral sales rallied the most since 2007 compared with gauges of exporters to the U.S., northern Europe and China, data compiled by Bloomberg show. The three latter indexes rose 4.4 percent, 4.6 percent and 7 percent, respectively.
“They can have a technical rebound, but structurally the countries lack competitiveness,” said Matthieu Giuliani, a fund manager at Banque Palatine SA in Paris, which oversees $5.1 billion. “These countries are moving in the right direction, but the road is long.” He said he isn’t buying Spanish or Italian stocks.
Goldman Sachs’s strategists said they started advising investors to short companies with sales in Spain, Italy, Greece and Portugal in 2010, meaning that they should borrow the securities and sell them on expectations they will be able to buy them back later at a lower price. The New York-based bank, which stopped the recommendation after Draghi’s July pledge, wrote in a September report that the stocks will trail European indexes “until their economies themselves start to outperform.”
Bets against peripheral equities have declined as indexes rallied and regulators stopped investors taking new positions. There were 680 million shares of IBEX 35 companies on loan, an indication of short-seller activity, as of Nov. 7, down 41 percent from the end of July, according to data compiled by SunGard Data Systems Inc.
The proportion of Grifols SA (GRF) shares borrowed by traders has fallen to 4.6 percent from 11 percent at the start of the year as the Barcelona-based maker of blood-plasma products rallied 95 percent, data compiled by Markit show.
Spain’s CNMV market regulator has banned all short-selling of equities and indexes, including bets made with derivatives, through Jan. 31. The restrictions aim to protect bank stocks from volatility while they restructure and could be removed “if there is a change in scenarios,” said Isabel Selas, a spokeswoman for the agency in Madrid.
Greece’s Hellenic Capital Market Commission prohibited short-selling from August 2011 to the end of January. The agency said on Nov. 8 it may end the measures early if equities keep climbing, the government wins the next portion of EU bailout money and banks are recapitalized.
In Italy, where the Consob regulator lifted its ban on shorting financial companies Sept. 14, the number of borrowed shares in the FTSE MIB Index (FTSEMIB) fell 13 percent to 1.82 billion from the end of July, data compiled by SunGard show. So-called naked shorts, when a trader sells shares that he has not yet borrowed, are still prohibited.
The restrictions on betting against many stocks in southern Europe creates a conundrum for investors, Lex van Dam, who helps oversee $500 million at Hampstead Capital in London, said in a Nov. 9 phone interview.
“I wouldn’t touch anything in those countries right now,” Van Dam said. “But at the same time you can’t easily short them either.”
While some investors want to bet on losses in Europe’s periphery, Sergio Cano is more bullish. The fund manager at Gesinter in Barcelona said he’s buying Enagas, the operator of Spain’s natural gas network, and wind-energy producer Acciona (ANA) SA as declining borrowing costs suggest they won’t be cut off from debt markets. Yields on Spain’s benchmark 10-year government bonds have dropped to 5.82 percent from a record 7.62 percent on July 24.
Enagas shares slumped 23 percent in the 12 months through May 31 before rebounding 17 percent. Spain is the company’s sole market, according to Bloomberg data. Acciona, a builder and energy provider based in Madrid that gets 65 percent of sales from its home country, has climbed 51 percent from a 14-year low on July 24. Enel, Italy’s biggest utility, surged 36 percent in the period. The company gets 40 percent of revenue from Italy and also owns Spain’s Endesa power company.
Companies in the IBEX 35 (IBEX) fell below the value of their assets this year for the first time since at least 1998, Bloomberg data show. The benchmark index trades at a so-called price-to-book value of 1.05 following the rally since July.
“You had a country-risk premium which meant these companies couldn’t finance themselves,” said Cano, who helps oversee $32 million. “We are buying stocks at levels that already reflect the slowdown we’ll see in demand.”
Previous periods of outperformance for companies exposed to Spain and Italy have faded.
After beating the Stoxx 600 by 14 percentage points in the eight weeks through May 8, 2009, stocks reliant on sales in southern Europe fell 18 percent through the end of November 2010 as the broader gauge gained 25 percent. A 16-percentage point lead in the two months through March 16 last year was followed by a 44 percent drop through July 2012.
The debt crisis will slow growth in the 17-nation euro region to 0.1 percent in 2013, the European Commission said Nov. 7, down from a May forecast of 1 percent growth. Spain’s economy is likely to shrink 1.4 percent, it said.
Spanish unemployment climbed to 25 percent in the third quarter as a deepening recession added pressure on Prime Minister Mariano Rajoy to seek a second European bailout. Industrial production in the euro area’s fourth-largest economy dropped 7 percent in September, a 13th straight decline, the National Statistics Institute in Madrid said Nov. 7.
Italy entered its fourth recession since 2001 in the final quarter of last year as tax increases and public spending cuts curbed demand. Prime Minister Mario Monti, who took office on Nov. 16, has enacted 20 billion euros of austerity measures and an overhaul of the pension system and the labor market.
The Italian economy will contract 2.4 percent in 2012 and 0.2 percent in 2013, according to forecasts from the Rome-based Treasury. Greece’s unemployment rate climbed to a record 25.4 percent in August, the government said Nov. 8, as a five-year recession deepened, worsened by austerity measures linked to the nation’s 240 billion-euro bailouts.
“You had a crisis, you had a response and then you had the rally,” said James Butterfill, who helps oversee about $64 billion at Coutts & Co. in London. “Now we are back into this complacency stage. Complacency leads to crisis again.”
Earnings for companies in Spain’s IBEX 35 will tumble 36 percent between 2010 and 2013, according to analyst estimates compiled by Bloomberg. Profits in Italy’s FTSE MIB Index will be little changed in the period, the data show, while income for Germany’s DAX Index will probably increase 30 percent.
Buying into the advance at this point is risky, according to Gilles Sitbon, who helps oversee $1.9 billion at Sycomore Asset Management.
“I am personally not chasing this rally,” Sitbon, whose fund has beaten 95 percent of peers this year, said in a Nov. 9 phone interview from Paris. “People have no idea what is going to happen with the fiscal cliff, with Spain, more austerity going through. Sequentially, things are getting worse.”
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