Will Spain Be the Next Domino to Fall?

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After the last few weeks of turmoil in European markets, jittery investors have every reason to be worried about the economic woes in the eurozone. After repeatedly claiming its government would not need a bailout, Ireland has officially reached out for an EU/IMF-style bailout that could cost, according to Goldman Sachs, close to $130 billion. This greatly dwarfs the Greek bailout from earlier this year.

Accordingly, Irish banks have taken a brutal hit to the chin. Allied Irish Banks (NYSE: AIB  ) has dropped by 10% and shares of Bank of Ireland (NYSE: IRE  ) have plummeted by more than 50% in the last month. Even National Bank of Greece (NYSE: NBG  ) has gone down by more than 25%.

Spain is a different beast
Now that the Irish bailout is all but hammered out, investors are turning next toward Portugal and Spain, two of the remaining PIIGS nations (which also include Italy) that seem most likely in trouble.

However, it would be premature to assume that Spain will need a similar style rescue package. Despite a pretty heavy concentration on the construction sector, Spain's economy is projected to see modest growth by next year -- pretty important considering it is the world's 12th largest economy as of 2009. In addition, Spanish public debt as a percentage of GDP was only 53.2% in 2009, compared with 115.8% for Italy, 113.8% for Greece, and 64.8% for Ireland.

So far this year, Spain's central government's deficit has fallen to 2.96% of GDP from 5.63% during the same period a year earlier, as a 11% boost in tax revenues helped to stem very weak housing and banking sectors. This drastic cut in the deficit is much more than Ireland, Greece, or Portugal have been able to achieve and is a promising indicator that the government has the stomach for reform.

So far the government has announced a massive overhaul of the pension system (freezing pensions for the next year), reduced infrastructure spending, and increased the value-added tax by 2 percentage points.

Investors not buying it
Nevertheless, yields on Spanish bonds are rising as fear propels itself into both the equity and bond markets. The additional yield spread that investors demanded in order to hold Spanish debt instead of German bonds rose to 222.8 basis points, a euro-era high.

With unemployment over 20% and being one of the last countries to emerge from the Great Recession, Spain is being punished for not having a more dynamic economy and for being slow to implement necessary reform. Banks such as Santander (NYSE: STD  ) and Banco Bilbao Vizcaya (NYSE: BBVA  ) have plummeted by more than 20% in the last month, and even companies such as Telefonica (NYSE: TEF  ) and Repsol (NYSE: REP  ) are watching their shares drop sharply.

Spanish Prime Minister Jose Luis Rodriguez Zapatero is trying to dispel fears about his country's ability to survive without aid, saying that there is "absolutely" no chance Spain would need any help. However, these statements have done little to quell panic, as Spain accounts for 11.7% of eurozone GDP and is roughly double the size of Ireland, Greece, and Portugal combined.

Simply put, a Spanish bailout would prove catastrophic and would ultimately wipe out the EU/IMF emergency fund set up earlier this year.

There's no easy way to play the international markets right now with so much uncertainty and ambiguity in the effectiveness of any central government to rein in spending. However, that doesn't mean you shouldn't stay in the game. Click here to read The Motley Fool's free report, 3 ETFs Set to Soar During the Recovery.

Both Jordan DiPietro and the Fool own shares of National Bank of Greece and Telefonica. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Read/Post Comments (9) | Recommend This Article (22)

Comments from our Foolish Readers

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  • Report this Comment On November 26, 2010, at 1:57 PM, lctycoon wrote:

    To put it quite simply, the EU and IMF does not have the money to do a bailout of Spain. It would be more appropriate to ask, does Germany have the money to bailout Spain? It doesn't. France also has a very high deficit-to-GDP ratio (about 9%). Could they be in the cards for trouble too?

    It's rather humorous that some of the companies that you mentioned are falling so fast. TEF does most of its business in Latin America, not Spain. This could be a buying opportunity...

  • Report this Comment On November 26, 2010, at 2:02 PM, TMFPhillyDot wrote:


    I totally agree with you.

    check out my article urging readers to purchase Telefonica some months ago:

    Thanks for the comment!


  • Report this Comment On November 26, 2010, at 3:11 PM, Glycomix wrote:

    Is the sky falling?

    I thought that Spain's banks endured and passed a stress test during and just after the Greek debacle.

    What makes this former stress-test irrelevant?

    Is there more-recent information?

  • Report this Comment On November 26, 2010, at 10:10 PM, candomarty wrote:

    Well said, Glycomix--there seem to be a lot of Chicken Littles out there, particularly in the financial press. Santander has, in my opinion, a really outstanding management that will win the day after all the adrenalin subsides. [And BTW, lctycoon, Banco Santander has approximately 75% of its money OUTSIDE of Spain, mostly in Latin America (but also other Europe), just like TEF.]

    I feel quite comfortable holding (and even buying--I modestly added to my position this week) STD until things return to normal, which they will, when the Cassandras pipe down.

  • Report this Comment On November 27, 2010, at 4:29 PM, malcarada wrote:

    Spain might need a bail out quite soon, unemployment is chronic and entrepreneurship in the country is non existent, agriculture and tourism alone will not be enough to save them.

  • Report this Comment On November 28, 2010, at 10:29 PM, neutrinoman wrote:

    The peripherals will probably default and leave the eurozone. That won't be fatal.

    The failure of Spain would be fatal.

  • Report this Comment On November 29, 2010, at 3:10 PM, EuroBob7 wrote:

    Add Belgium to your watch list. Spain wont fail but its banks will be impacted due to their big investments in Portugal - which could be next.

  • Report this Comment On November 30, 2010, at 2:07 PM, Veritas1010 wrote:

    This is another buying opportunity for Telefonica. The same could be argued for Banco Santander.

    Telefonica last reached these lows during the last round of European malaise this past summer, strick price ? I would say anywhere in the 50's for a real steal. However, I'm not sure it will bottom this low.

    Go long, and reap the benifits of a diversifed telecommunications company in a growing economic environment like Brazil. And, by the way, they even beat Vodafone in the UK with O2, not bad. A reflection of saavy management.

  • Report this Comment On September 15, 2011, at 7:44 PM, joaquingrech wrote:

    Hi there. Spaniard typing here.

    I don't think Spain will need a bailout. Banco Santander and BBVA are two of the best and most financed banks in the world. I'm not making that up out of nationalistic pride, it was even said during the European stress test, they are ahead of german and french banks. Also most of their earnings are from latinamerica and asia these days. So banks are sound.

    About the bailout of Spain... well... i think Italy was not even looked upon and then suddently it surprised us. I don't think we'll need a bailout in the pure sence of the word. Although we do need it partially and we already got one since the ECB pushed yields down for all of us.

    It all depends how well they handle Greece. It's a crisis of confidence, if greece goes down, people just runs away from anything Europe. Pushing yields higher is devastating for all of us. So it depends how that ends up.

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