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Pain In The Spain ETF (EWP) Continues

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As the European debt crisis marches on, the epicenter of the disaster continues to shift west, away from Greece and towards the Iberian Peninsula and Spain in particular. This is especially troubling as Spain is—by a PPP look—one of the 15 largest economies on earth and the fourth biggest in the euro zone.

In other words, trouble in Spain makes the issues in Greece seem insignificant in comparison, as Greece is a relatively small economy while Spain’s trillion dollar output has a huge influence on the broader euro zone region. Greece can be bailed out, but it remains to be seen if the same can be said for Spain (read Three Unlucky Equity ETFs).

To top off this problem, it appears as though Spain has fallen back into a recession during the first quarter of the year, the second one since 2009. According to the National Statistics Institute, GDP fell 0.3% for the second quarter in a row, putting Spain’s plan to push down the budget deficit in jeopardy while further highlighting the massive unemployment issue that is plaguing the country.

"We fear things are likely to get worse before they get better," Martin van Vliet, a senior euro-region economist at ING Bank in Amsterdam said in a note. "The recession will almost certainly deepen in the coming quarters, pushing unemployment to even more dramatic highs."

Thanks to this poor trend, Spanish 10 year government bond yields have risen by about 40bps in the past month and are now holding steady above the 5.8% mark. While this is still well short of the 52 week high for this benchmark, investors should be concerned over another spike in these bond yields which could boost the general uncertainty over the Spanish economic environment (read For Europe ETFs, It’s Hard To Beat Switzerland).

Unsurprisingly, this pessimism has spread into the equity market as well with the main way for investors to play Spain in ETF form, the iShares MSCI Spain ETF (EWP - Free Report) . The ETF was down about 2% on the news of the recession and it has trailed broader European markets significantly in recent months as well.

In fact, EWP has lost about 8.7% in the past month, compared to a -3.6% performance for the broad iShares MSCI EMU Index Fund (EZU - Free Report) and a -6.8% slump in the iShares MSCI Italy Index Fund (EWI - Free Report) . Even more troubling is that the Global X FTSE Greece 20 ETF (GREK - Free Report) (down 8.3% in the time period) has done better than the Spain ETF in the most recent one month period.

Furthermore, EWP’s focus on certain industries hasn’t helped the product in recent weeks either. Two of the fund’s top three holdings are financials, which account for nearly 28% of the total assets. Beyond these two giants, the fund has nearly 40% of its total portfolio in the sector, easily one of the most impacted by the sovereign debt crisis.

In addition to this, issues related to the recent nationalization proposal in Argentina have rocked many of the Spain ETF’s securities as well. In particular, it has been a rough period for Repsol YPF (REPYY - Free Report) which is the parent company for the in focus YPF. The stock makes up just under 4% of EWP and it has lost over a fifth of its value in the past month thanks to the proposals in Argentina (see Argentina ETF In Focus On Nationalization Proposal).

There are now modest worries that similar situations may plague other Spanish firms that have sizable operations in the Latin American country, although this seems unlikely in the near term due to the global backlash from the YPF move. Nevertheless, the heightened risk comes at a pretty terrible time for Spain, particularly now that the country is in a double dip recession (see more on ETFs at the Zacks ETF Center).

Will the pain continue?

Unfortunately for investors, the pain in the Spain ETF seems likely to continue. Further budget cuts, while probably good for the long term, look to only boost the country’s incredible unemployment rate and push the nation further towards a full blown crisis. The only hope appears to be modest bond yields and a slow recovery, although even this seems unlikely at this point in time.

As a result, investors may want to continue to cycle away from the Spanish ETF in favor of other, stronger European nations at this time. Beyond staying away from the country as a long investment, the Spain ETF could make for an interesting short candidate, possibly as a pairs trade with another euro zone ETF, for those looking to make a less risky bet on continued weakness in the Spanish economic situation (see 11 Great Dividend ETFs).

However, with that being said, the Spain ETF could make for an interesting pick for value investors who are starved for yield. The current SEC 30 Day Yield on the product is about 5.8%, a level far higher than other European ETFs. Given this, the product might be an interesting choice for those with a high risk tolerance and desire for more income, but for all other investors, an avoidance of Spanish securities seems to be the best play going forward.

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