Spanish Equities - The Real Bull Run

Spain just celebrated their Festival of San Fermin with the traditional Running of the Bulls. The single mindedness of a bull and the tremendous force with which a bull can charge, is quite a thing to witness up close. Once a bull is charging full steam ahead, getting them to change direction requires quite a distraction. I can now fully appreciate the term "Bull Market" after my visit to Spain.

While experiencing the Running of the Bulls was on my bucket list, there was work to be done in examining Spain and getting a glimpse at an anti-austerity region like Valencia.

Goldman Sachs released their 5 year capital markets expectations across asset classes and investments. Surprisingly, they have Spanish equites as their strongest market.

With expectations of 14% annualized returns for Spain vs only 3% for the S&P 500, it's worth a bit of a deeper dive.

Spain is an easy economy for us to understand. The economy is consumption driven, much like ours. While U.S. GDP is 70% consumption, Spain is about 60% with 20% generated by the Government similar to the United States.

The main driver for optimism about Spain is the recovery and stabilization in their economy.

They have had their best GDP growth rates since Q2, 2007. Clearly Spain has lifted themselves out of a long slow decline.

According to Trading Economics, "year over year the economy expanded 2.7 percent, beating expectations, mainly driven by domestic demand. Household consumption rose 3.5 percent while gross fixed capital formation grew 6.0 percent."

The dynamic that can likely lead to a longer sustained profit period is the fact that Spain has massive unemployment.

You're seeing that number correctly, it's 23.78%. Certainly improved from it's worst in 2013 but well above their long term average of 16.37% since 1976. The level of unemployment will certainly allow business to meet growing consumption demand by hiring more people and not necessarily paying more in wages. In other words, margin improvements can be a long cycle phenomena in Spain.

My observations and discussion with those in government lead me to some basic conclusions:

• Spain suffered the same overcapacity issues the United States had during the financial crisis.
• There are many amazing public projects that are totally unsustainable to fund.
• There are many housing projects mothballed for now, especially near resort and vacation locations.
• Spanish culture does not lead one to conclude they prioritize profits over lifestyle.
• Cars, technology, 2nd homes are all desirable (sounds familiar).
• Personal portfolios are heavily invested in bonds directed by the banks with no input or planning by the investor (in general).

The bottom line on Spain is their earnings growth rate is now showing signs of life. Looking at the IBEX Index through 2018, we can see Spanish earnings are projected to grow at a rapid pace. The compound annual earnings growth rate is projected to be 18%.

IBEX Estimated Earnings Growth 18%

While Spain is not in first position for tilted allocations, it's a great example of an improving Europe. With 10% of our equity allocations invested in Europe it's good to see some organic growth. We should benefit if in fact, Goldman Sachs is right and the bull is allowed to run.

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Tim Phillips, CEO – Phillips & Company