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More Trouble Ahead for Italy and Spain ETFs?

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In the past six months, European ETFs have been soaring higher. Worries over a broad debt crisis faded from memory, while a rosier outlook for the global economy allowed many to buy up European ETFs in droves.

This was especially true in the troubled PIIGS markets like Spain and Italy, which were at the heart of the crisis. After all, if either of these trillion dollar economies face real trouble, it could spell doom for the euro zone experiment, casting a recession cloud over the entire continent.

This didn’t come to pass in the latter half of 2012 though, as both (EWI - Free Report) representing Italy, and (EWP - Free Report) representing Spain, added about 20% in the second half of the year. This signifies a huge reversal from the first half of 2012 in which both were deep in the red, suggesting that momentum had shifted—and quite strongly—to being positive over the European outlook heading into 2013 (read The Key to International ETF Investing).

While this trend continued into the first part of 2013, some are worried that it might have topped out in the near term, largely thanks to a new crop of issues plaguing both of these countries. Except, this time around, debt isn’t the crux of the issue, politics are.

First in Spain, current Prime Minister Mariano Rajoy is facing a surge of anger from the general population over bribery accusations, with some calling for his resignation. While it remains to be seen how deep or extensive this issue will become, a political crisis over cash in a country dealing with austerity measures and record unemployment cannot be good for national stability (read Is the Ireland ETF No Longer a PIIGS Member?).

Meanwhile in Italy, the country is approaching an election later this month with some predicting a surge for former Prime Minister Silvio Berlusconi and his party at the polls. Somewhat hilariously, Berlusconi promised to get rid of a new property tax—saving owners about $5.4 billion—which was only (arguably) necessary due to his mismanagement of the economy last time he was in charge.

While Berlusconi has political issues of his own, thanks to a variety of scandals in his own right, it remains to be seen if he can recapture the Prime Minister position. Either way, it could be a volatile stretch for Italian securities as electoral uncertainty casts a shadow over the troubled market (see ETFs for 3 of the Cheapest Markets in the World).

Thanks to these issues, equities in both countries plunged earlier in the week while bond yields surged. In fact, sell-offs in both EWI and EWP were so extensive that they erased all of the gains that investors saw to start 2013 in the products, leaving both in the red.

Bottom Line

While the debt part of the European crisis may have taken a breather, the region isn’t out of the woods yet. Political crises are now the main worry for the euro zone and they look to drive EWP and EWI in the short-term.

This can create some significant volatility, as we have seen to start February, with both funds plunging by 4% (or more) one day, only to add a few percentage points back the next session. And with both crises looking to be relatively longer-term stories, this could be the trend for both the Spain and Italy ETFs for the intermediate future (read Three European ETFs with Incredible 2012 Gains).

Currently, we have a Zacks ETF Rank of 4 or ‘Sell’ assigned to both funds, meaning that we believe underperformance is in the cards for both nations this year. If the recent issues have been any guide, this could certainly be the case for both funds in 2013, suggesting that investors may want to look elsewhere in Europe for their international exposure.

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