Spanish equities and Catalan chaos
Catalan President Carlos Puigdemont’s decision to suspend independence for the region that accounts for 19 per cent of the Spanish GDP averts secession and the gravest political/constitutional crisis since a 1981 abortive military coup. This decision means a negotiated solution to Catalonia’s political future will emerge as both the central government in Madrid and Barcelona are forced to compromise. For now, the worst possible scenario for Spanish equities and the euro has been averted since Puigdemont conceded that while the October 1 referendum gave Catalonia a “mandate” to secede (2 million Catalans voted for secession though the turnout was only 43 per cent). He has ruled out any immediate independence from Spain. However, the Catalan President’s decision is accompanied by difficult conditionalities. This means the biggest existential crisis in Spanish politics since the civil war and fascist victory of General Francisco Franco continues.
It is ironic that Spain has been of the best performing economies in Europe, with GDP growth of 3 per cent in 2017 and at least 2.7 per cent expected next year despite the Catalan secessionist vote. The Spanish Ibex 35 was the best performing stock market index in Europe until the political storm clouds darkened and led to a 10 per cent correction since May. It is however crucial to point out that at least 74 per cent of Ibex 35 corporate profits are generated outside Spain, primarily in the emerging markets of Latin America. This is most true of banks like BBVA or Banco Santander or utilities like Iberdrola, retailer firms like Inditex and construction firms like Obrascon and ACS.
The immediate strategy on the Catalan President’s historic political decision is to buy deeply oversold, predominantly domestic businesses like CaixaBank and Banco Sabadel. Yet the prospect of protracted political negotiations between Madrid and Barcelona mean that the risk pre- mium on Spanish equities remains elevated, which will be reflected in a rise in both Spain’s credit default swap and Spain’s sovereign debt credit spread over German Bunds. This issue will also distract the Madrid government from structural reform, which would negatively impact Spain’s stellar growth rate. There is also a danger that Puigdemont’s pullback from the brink will create apposition to him from hardline secessionists in the Catalan movement. The “Slovenia model” of a negotiated split favoured by some Catalan power brokers is no model – as it took place outside EU jurisdiction and preceded the Yugoslavian civil war. The worst possible outcome will be if Prime Minister Rajoy asks the Spanish Senate to seize direct control of the autonomous Catalan government, an outcome that could cost human lives and lead to an offshore capital exodus from Spanish equities.
For now, trading in German, French and Benelux equities suggests financial markets have not priced in any contagion risk from Spain, particularly now that Catalonia has suspended the prospect of an immediate declaration of independence. This will also help boost the euro above the key support levels and make it more correlated to economic data flow and ECB policy, not political noise from Spain.
It is no coincidence that the euro spiked up to 1.1817 immediately after Puigdemont’s speech to the Catalan parliament. This was the euro’s best one day performance since early September. Even the Spanish – German sovereign bond spread is now much lower than the Portuguese spread, a metric that reflects less concern about systemic credit risk from Catalan politics.
Madrid has raised the political stakes with Barcelona by insisting that the Catalan President declare the secession void and not just suspend a declaration of independence. This means that the financial market have prematurely celebrated the end of the Catalan crisis, after all the Ibex 35 soared to 10,300 on news of the suspension and outperformed global equities. The euro ended the week at 1.1870 though its strength was also due to weak US CPI data and dovish voices in the Fed minutes. If Madrid plays hardball and revokes the Catalan government’s autonomous status, the risk premia on Spanish equities and debt could spike again. This could lead to another sworn in the Euro and a spike in credit default swaps on Spanish sovereign debt. It is unwise to be complacent about the future course of Spanish/Catalan politics.