The Spanish market is buoyant, driven by liquidity flows from private in-vestors, who are moving to equity from mutual money market or bond funds, as Spanish bond rates converge on the Bund.

Cecilia Planiol, chief economist at Banco Santander de Negocios in Madrid, says that inflation, at around 1.6%, is at the bottom of the cycle. She expects a rise to 2.0-2.1% this year, although the 10-year bond rate, currently at 6.5%, will continue to converge on German rates. We think we can reduce the spread against German bonds from the current 85 basis points to 75 next month and 60 by the end of the year. The problem is that yields in Germany could rise this year, from 5.7% now to 6.0 or 6.2%."

"Once everyone is convinc-ed the German economy will recover in the second part of the year, bonds will come back up. We don't expect Spanish rates to maintain 6.5% but to be a little bit higher."

Diego Prado, head of re-search at Schroders in Ma-drid, is optimistic about Spanish prospects. "Spain has made a lot of progress, particularly on inflation. The May figure came down from 2.2% to 1.7%, well ahead of the consensus. Spain meets all the Maastricht criteria except for the budget deficit and this is trending downwards."

Ignacio Montego, head of research at Merrill Lynch, says Spain "now has a very good chance of making EMU". Both analysts agree that the prospect of EMU starting on schedule with Spanish participation has become much firmer. This helped to boost the market.

Prado continues: "We have a declining interest rate be-cause of declining inflation, prompting a lot of investors to switch from money market funds into equities. Domestic liquidity is driving the market."

Montego adds: "Spanish private investors have moved an unprecedented volume of Pta1trn to equity since the beginning of the year. We could see another Pta2trn ($6.8bn) or more in the coming two years, a very substantial amount in so small a market."

This environment, he continues, has ensured success for the privatisations of Telefonica and Repsol, and bodes well for the upcoming Pta500bn Endesa privatisation. Prado predicts a myriad of IPOs.

Adds Montego: "In this environment the amount of privatisation paper is very limited. Institutional investors have been a net seller, because domestic investors are buying everything and this process has just started."

Market valuation, says Montego, is historically high but he adds: "We are generally cautious about Spanish valuations, but we believe that the correction is unlikely to be substantial because of the flow of funds."

In terms of sectors both analysts favour banks. Prado explains: "The banks are do-ing very well, particularly those present in Latin America. They are protecting their margins better than others." However, he cautions that despite good first-quarter results the long-term interest rate climate is not good for the banks' prospects.

Both analysts underweight construction due to cutbacks to infrastructure projects and are neutral on the restructuring utilities, while Prado suggests that low interest rates should begin to feed through to property. "From a top down perspective there aren't any strong reasons to overweight any specific sector."

John Lappin"

Topics