Divergent paths for Europe’s periphery

Countries such as Spain and Ireland have seen their fortunes improve in the wake of bailouts and austerity measures. But austerity has not worked for all, with Portugal and Italy only gradually improving and Greece standing out as the exception that proves the rule.

Jake Robbins, manager of the Premier Global Alpha Growth fund, notes that since these countries were banded together as the ‘periphery’ of Europe in 2008, “there has been some divergence in their fortunes”.

He explains: “Greece faced a larger bailout than the others and, subsequently, has remained in a weaker position. Last summer saw the third Greek bailout in five years and, while markets seem to be focused on other regions, it’s hard to imagine we have seen the last of the Grexit headlines, especially considering the harsh austerity measures that were conditions of the most recent bailout and their inevitable impact on economic growth.”

Mr Robbins points out this divergence is highlighted in the 10-year yields of the peripheral countries, with Greece remaining above 8 per cent; the others below 3 per cent; and Ireland currently yielding less than 1 per cent.

“Ireland is expected to be the fastest growing economy in the eurozone with a growth forecast of 4.5 per cent, as its export economy is supported by a weak euro. Spain grew year on year at 3.5 per cent in the fourth quarter as consumer spending improved and Portugal began early repayments on the bailout loan last year,” says Mr Robbins.

Serge Pepin, investment strategist at BMO Global Asset Management, EMEA, adds that in 2015 virtually all peripheral economies managed to narrow their central government budget deficits relative to 2014 by either containing or cutting spending or, in some cases, higher-than-expected public investment inflows.

“Of the five major euro-area countries that had been deemed economically and financially troubled in the aftermath of the 2008 financial crisis, Spain and Ireland stand out as wonderful success stories,” he says. “Ireland was crowned the fastest growing economy of the euro area in 2015. It is poised to keep that title in 2016 due to a sharp improvement in public finances and sustained employment growth.”

The problem with Italy is you haven’t really seen any evidence of serious structural reform. Niall Gallagher, investment director at Gam

Niall Gallagher, investment director at Gam, agrees that the two best performing of the peripheral countries are “Spain and Ireland – where domestic demand has corrected to such a degree that we see a multi-year bounce in internal demand as inevitable”.

“In the case of Ireland, it is running a large credit account surplus which suggests there is room for internal demand to actually bounce quite hard.

“A few areas we focused on in Ireland were housebuilding and those companies exposed to housebuilding. Given the shortage of housebuilding in Ireland following the collapse of the housebuilding industry, [these companies are] very well positioned,” says Mr Gallagher.

Portugal is also highlighted as an interesting opportunity where some businesses, such as those in the telephony and cable sectors, are expanding.

Mr Pepin adds: “Portugal’s economy is aided by private consumption and exports. [But] There remain uncertainties in terms of the country’s government budget and the government’s anti-austerity stance.”

He is more cautious, however, on Italy’s prospects, noting: “While Italy, the region’s third-biggest economy, has recovered on the back of major labour and financial reforms, the country is still grappling with a significant debt-to-GDP ratio of more than 132 per cent.”

Mr Gallagher also remains sceptical on Italy, adding: “The problem with Italy is you haven’t really seen any evidence of serious structural reform. You see this most clearly in Italy’s banks. They were bailed out in 2012 by Mario Draghi but the political class has not followed through with the required structural reforms.”

Despite the periphery’s success stories, there are still potential headwinds. In terms of Ireland, Spain and Portugal, Mr Robbins states: “Two of the three have no governments and Portugal has a fragile left-wing alliance.

“Debt-to-GDP figures are high and unemployment [is] still concerning, especially youth unemployment which stands at 45 per cent in Spain. They have made good progress since the bailouts and are moving in the right direction, but it’s unlikely it will all be plain sailing from here.”

Nyree Stewart is features editor at Investment Adviser