Sunday’s vote on Catalonian independence from the Spanish central government could create some fireworks in Spanish equities markets. What exactly happens will most likely not be dependent on the actual results of the referendum but on the Spanish government’s reaction to it and the aftermath.
By all accounts the vote will be overwhelmingly in favor of independence and secession from Madrid. This because those who support having the vote in the first place support secession, and those who oppose the vote oppose secession and don’t plan to vote anyway. So it is not the results of the actual vote that will move markets. What happens in the weeks ahead will be key.
Madrid has two options following the vote. The government can either try to appease the Catalonians, whose largest city is Barcelona, by giving them more autonomy, lower taxes, less burdensome regulation, more representation and the like. Or it can be reactionary and punitive. The reaction of Spanish equities markets will largely depend on the choice that Madrid makes in this regard.
Initial indications are that there will be a backlash against Catalonia. Madrid is actively fighting against the vote taking place, even going so far as threatening to confiscate legal documents of those who participate in the vote. If that doesn’t broadcast the severe insecurity from Madrid, nothing does. Now police are being called in to stop the vote, after measures have already been taken to scramble logistical efforts. Catalonians are not likely to take kindly to these efforts and are likely to fight back harder against any punitive measures or other backlash from Madrid, possibly in a tax revolt. In other words, being reactionary on the part of Madrid is likely to increase the chances of Catalonian secession in a practical sense, if not in name.
The effect of a prolonged spat between Catalonia and Madrid is likely to push Spanish equities down, at least in the short term. Spanish markets will begin to ask how Catalan independence could be practically similar to Brexit. If it takes effect, would Catalonia still be part of the Eurozone? The European Union? What happens to Spanish bonds in the meantime? These questions are impossible to answer at this point, and that uncertainty itself could cause Spanish equities to slide.
Backlash against Catalonia would undoubtedly embolden and strengthen the secessionist movement there, which would only gain steam as it identifies itself in opposition to Madrid.
Practically, traders may want to play this weekend’s vote by going short Spanish equities short term. Relevant ETFs include the iShares MSCI Spain Capped ETF (EWP, Financial) and the currency-hedged version of the same (HEWP, Financial).
Spanish bonds may also signal trouble in the coming weeks. Spain is already heavily indebted at 100% of GDP for the last four years and no sign of dropping. Unemployment has been chronically high for decades, back to the death of dictator Francisco Franco in 1975, and income taxes are above 40%, not including a social security tax above 30%. With tax rates like these, it becomes clearer why some Catalonians want independence.
Disclosure: No positions.
