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The Pain in Spain: More Room for a Short ETF Bet?

An exchange-traded fund tied to Spain’s equity market is down sharply but may have further to fall.

With Spain the latest euro zone member to inspire fear among sovereign bond investors, exchange-traded funds that invest in the country’s equities are seen as a profitable means of shorting its debt.

Daniel Sckolnik, a senior analyst for Santa Barbara, California–based research firm Sabrient Systems, cited three ETFs in a recent Periscope column in its weekly investment newsletter: VGK (MSCI European ETF), IEV (iShares S&P 500 Europe 350 Index Fund) and, as Sckolnik put it, “for those who want to go for a more laser focus,” EWP (iShares MSCI Spain Index Fund).

But even the purest ETF play here isn’t as straightforward as it sounds, as a piece by Michael Johnston on the ETF Database website recently pointed out. 

The two largest holdings of EWP are Banco Santander (at 20 percent of the portfolio) and Telefónica (at 18 percent).

And both of those companies count on Brazil for a big chunk of earnings and an even larger portion of growth, and that emerging market is not at all correlated to Spain.

Observed Johnston, “Spain is still a key market, but hardly the only driver of those two companies (and therefore the entire ETF).”

In an interview with Institutional Investor, Sckolnik countered: “It’s not really diversified. Just look at its performance to date.”

In fact, it may seem a bit late in the game for this move. EWP is trading at $25.64 as this went to press, close to a 52-week low, and 61 percent off its high of $42.02.

Yet Sckolnik doesn’t think all of the potential bad news is already reflected in the ETF’s price, notwithstanding the support the European Central Bank has been offering all of the euro zone’s troubled economies.

As he put it in his column: “Anyone who has bought into the notion that the structural problems of [the] monetary union have been addressed with the Europe Central Bank’s own version of quantitative easing ... may be surprised when the next round of serious problems breaks out among the PIIGS (Portugal, Ireland, Italy, Spain and Greece) in 2012.”

Sckolnik is even more explicit in his interview, “The austerity measures will not be able to be implemented, they’re going to break promises already made, investors will be spooked, and the euro zone will sink further into recession.”

As to the question of whether EWP has further to fall, Sckolnik says, “The answer is yes.”

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