How To Play The Spain ETF; And The Euro Zone Slump (EWP, BUND, BUNL, GGOV)

Eric Dutram: Roughly a month ago, we wrote an article about how the downturn in the Spanish market was continuing, pushing the main Spanish ETF (NYSEARCA:EWP), down significantly to start the year. However, it appears as though the pain in the Spain ETF was just beginning, as the product has slumped heavily since the start of May and is in the neighborhood of its 52 week lows.

In fact, it is making the fund’s performance to start the second quarter of the year look downright bullish. During that time frame, the popular product lost about 8.7% compared to a roughly 15% slump since the start of May (see UK ETF Investing 101).

Thanks to these kinds of performances, the product has lost close to 28% in the past three months alone far outpacing many other European ETFs on the downside during the same time frame. This has put the product into second place in terms of total negative returns so far in 2012 with only Greece having a worse start to the year.

With this kind of pain, some long term focused investors might be thinking about making a play on Spain at this time. After all, EWP is currently sporting a P/E below 8.8 while the price/book and price/sales ratios are both below 1.0 at this time. This could suggest that some decent values are beginning to develop for investors with a high risk tolerance (read Is It Time To Buy Europe?).

Unfortunately, one has to wonder if it is time to jump into Spain just yet, as evidenced by recent comments from the country as well as the lack of progress on either broad euro zone or G-7 market intervention.

Seemingly without a backstop from stronger European nations, Spain and other PIIGS markets could face some more trouble in the near future. Meanwhile, a recent ‘emergency’ G-7 meeting appeared to resolve little either suggesting that unless a deal was worked out in secret, it will be up to the euro zone to figure out how to get some of the world’s biggest economies out of their current predicament.

This situation appears to be rapidly approaching an end game scenario (finally) as the rhetoric out of Spain seems to be increasingly dire. Earlier this week the Spanish Treasury minister suggested that the markets were shutting the country out of the fixed income world and that broad European help would be needed to assist the banking sector (see Three European ETFs That Have Held Their Ground).

The timing of the statement seems a little odd as it comes right before a debt auction on Thursday, potentially spooking market participants who were already shaky about Spain’s prospects. Current yields are now firmly above the 6.0% mark—roughly at 6.3% at time of writing—and are near the highest level investors have seen since late November of 2011.

“The market is quite nervous still, these remarks will make the auction more difficult,” said Emile Cardon, market economist at Rabobank in a Reuters article.

Beyond this, concerns are also building over the government’s ability to push capital to struggling private banks without more euro zone help. Already, it looks as though Bankia will receive about 19 billion in euros while speculation is building that about 40 billion in euros of additional capital for the rest of the Spanish banking sector in order to shore up the space.

While this isn’t a huge sum when compared to the vastness of the Spanish economy, or especially the broad euro zone economy, which is nearly equal to that of the United States, it is a troubling amount nonetheless. This is even more apparent when considering that Spain can’t really sustain the current debt load at rates approaching 6.5%, implying that a broader bailout of Spain might be necessary.

Since Germany seems unwilling—at least on the surface—to do this, Spain’s troubles look likely to continue at least in the near term. However, a bailout does still seem likely at this time, as costs are relatively low at this stage and major European nations cannot afford the euro crisis and a default to reach Spain and eventually Italy (read Is the Italy ETF Next?).

If that happens, a situation which would engulf two of the biggest 20 economies in the world, a near depression seems likely to ensue in Europe, a scenario that even Germany will want to avoid.

Thanks to these trends, it is probably not time to get in on Spain just yet as there is still too much risk in the market. Whether the Spanish ETF, however, is doomed seems to be another story as northern European nations seem poised to eventually ride to the rescue for Spain and many of the other PIIGS nations.

Instead, it could be an ideal time to load up on the European nations that have managed to maintain some level of strength during this time. A look outside the euro zone may produce a few choices, although it looks as though oil-dependent economies might not be the best choice with severe weakness in broad commodity markets.

Beyond these equity markets, a closer look at some of the German bond ETFs could also be a safe place to maintain capital at this time in the European market. Currently, investors have three choices; (NYSEARCA:BUNL), (NYSEARCA:BUND), and (NYSEARCA:GGOV), to choose from, all of which might not be the most heavily traded but can provide targeted exposure to the bond market of the region’s strongest country (readFollow Buffett With These Developed Market Bond ETFs).

Over the past month, all three of these have held up nicely, easily trouncing their equity counterparts in the time frame. As a result, for investors who think Spanish ETF pain may continue to sink the broad European market, a look at any of these bond ETFs may be a better choice for those seeking euro zone exposure while Spain and the rest of the EU attempts to sort out their many issues before a true crisis develops on the continent.

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Written By Eric Dutram From Zacks Investment Research

In 1978, Len Zacks discovered the power of earnings estimates revisions to enable profitable investment decisions. Today, that discovery is still the heart of the Zacks Rank, a peerless stock rating system whose Strong Buy recommendation has an average return of 26% per year.

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