Some Eurozone stocks have suffered too much

GIVEN the turmoil in the Eurozone’s financial markets, it would be tempting for the contracts for difference (CFD) trader to avoid the region. After all, there are surely plenty of other markets that appear to offer greater stability and better prospects.

And it has been easy to focus on events elsewhere. Whether it was concern about the health of the ailing US economy and the subsequent anticipation of further Fed action or the escalation of currency war rhetoric among emerging market policymakers, there has been plenty else to keep investors’ minds occupied.

But despite renewed fears about the Eurozone periphery, the volatility provides CFD traders with plenty of opportunities. For a start, there is little sign (yet) that this is a systemic crisis posing a real risk of contagion. Unlike in May, the impact has been felt more acutely in the specific government bond markets – Ireland and Greece – rather than a more widespread risk-reduction exercise, says Nomura’s European strategist Ian Scott.

Secondly, Credit Suisse’s Andrew Garthwaite argues that there is “a near-zero chance of core Europe walking away from peripheral Europe, as this would cost them at least $600bn on our estimates”. Yet core Europe will remain strong, with equity markets in Germany, Sweden and Switzerland all faring well.

In terms of peripheral Europe, Garthwaite and his team believe the region has to go through more deflation. “This means that cyclical plays in Spain, Greece and Portugal and Ireland should, in our opinion, be generally avoided (banks, retailing, construction etc) and even some of the less cyclical sectors are likely to be vulnerable,” they say. This includes the Portuguese motorway network operator Brisa and TT Hellenic Postbank, both of which have more than 70 per cent domestic sales exposure.

But the Eurozone debt crisis has not had a uniform effect on the Club Med countries, creating some near-term opportunities for CFD traders. Nomura’s Ian Scott points out that key country-level benchmarks do not necessarily reflect the problems in the sovereign bond markets “Spanish stocks, in particular, have declined as much as those in Greece in the past month despite a radically different bond market environment.”

Spain and Italy also have sounder fundamentals. Scott says Spanish and Italian earnings assumptions have risen gently in the past few months and now stand just 15 per cent and 35 per cent below their peak of cycle levels respectively. “Contrast this with the complete collapse in earnings assumptions in Ireland and the ongoing decline in Greece,” he adds. (See chart.)

“Both taking account of the recent movement in sovereign yields, earnings and valuations, it seems to us as if the Spanish and Italian markets have been relatively harshly treated by equity investors,” he concludes. If you agree, it’s time to be reconsidering those Eurozone trades.