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Rocketing borrowing costs across Europe haven't stopped equity investors cashing in

Emma Charlton and Alexis Xydias

Published 21/04/2011 | 05:00

EVEN as bond investors drive borrowing costs for Europe's most-indebted nations to records this year, equity investors are piling in, with Italy, Spain and Greece leading market gains for the region.

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Stock indexes in so-called peripheral Europe rose by an average of 5.1pc, including dividends, while investors lost an average of 2.4pc in the sovereign debt of Portugal, Italy, Ireland, Greece and Spain.

Equities benefited from optimism about corporate profits, while fixed-income markets were hurt by speculation about a possible bond restructuring in Greece.

"In the equity markets, global investors have become less panicky," said Holger Schmieding, chief economist at Berenberg Bank in London.

"For those countries that are now in intensive care, we will have pretty much the same as we've seen in Greece: bonds will stay weak."

Greek two-year notes rose above 20pc this week, the most since Bloomberg began collecting the data in 1998. The nation's 10-year bond yields climbed to a record 14.59pc.

The cost of insuring Greek government debt rose to an all-time high of 1,211, according to CMA prices for credit-default swaps, indicating a 64.5pc chance of default in the next five years. Portugal's five-year bond yields also rose to a record.

"I am pretty sure Greece cannot avoid a restructuring," said Giacomo Chiorino, chief operating officer and head of asset management at Nuovi Investimenti Sim in Biella, Italy, which manages €75m.

"Without big growth, it is impossible to get out of this. We could end up with more countries needing help."

Earnings for companies in the Stoxx Europe 600 Index probably will increase about 35pc during the next two years, according to analysts' estimates compiled by Bloomberg.

Profits in Spain, Italy, Greece and Portugal will climb by an average 32pc. Irish companies will likely be profitable after posting losses in 2010.

"It makes perfect sense that equities have shrugged off some of the bad news and bondholders haven't," said Gary Jenkins, head of fixed-income research at Evolution Securities in London.

Take Telefonica. Spain's largest company and the biggest member of the nation's IBEX 35 has a dividend yield of 8.59pc, 317 basis points more than the benchmark 10-year Spanish bond.

"With equities, you get dividends and you have the potential for growth," said Patrick Armstrong, managing partner at Distinction Asset Management in London, which has £220m (€251m) in assets under management.

"With sovereign debt, you get dividends at most, and a little bit less if the country has to restructure or default on its debt."

Credit default swaps insuring Telefonica's debt cost 136 basis points, 97 less than those linked to Spain. Spanish sovereign contracts overtook Telefonica's in November 2009 on concern the government deficit was becoming unsustainable.

"The relationship between sovereign risk and corporate risk has completely turned on its head," said Chris Parkinson, strategist at Christopher Street Capital in London.

"The credit market is still very, very concerned about the underlying risk of the European government balance sheets."

Portugal Telecom, that country's largest phone company, pays a dividend yield of 7.95pc, the highest in the country's PSI-20 Index. By contrast, Portugal's 10-year bonds yield 9.1pc.

So-called defensive companies, or those with earnings less susceptible to swings in the economy, rank among Europe's best performers this year.

Shares of Greece's Thessaloniki Water and Sewage and Hellenic Telecommunications Organisation climbed at least four times more than the 3.9pc advance of the Athens Stock Exchange General Index this year.

"We believe there will still be some very good stock-picking opportunities in those markets," said Jean Medecin, of Paris-based BNP Paribas Asset Management.

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