The Ibex has well and truly lost its spring. Spain's stock market is down 27% this year, losing another 2.3% Tuesday amid fears over the country's economy and banking sector. The high level of cross-ownership between the index's 35 companies is exacerbating the market slump. Spanish banks, in particular, are under pressure to sell their holdings in unconnected companies to help repair their balance sheets. In all, stakes worth €22 billion ($27.6 billion)—equivalent to 9% of the IBEX-35's market capitalization—are ripe for divestment, UBS estimates. That overhang adds more complexity for investors trying to judge just how cheap Spanish stocks have become.
Pre-financial crisis, Spanish banks and other corporates took advantage of cheap funding to build stakes in noncore businesses. But highly leveraged companies in troubled sectors like construction are now under pressure to pay down debt: witness Actividades de Construccion y Servicios's ACS.MC -0.47% decision last month to sell down stakes in Iberdrola IBE.MC -3.34% and Abertis ABE.MC -1.37% .
Banks are also under pressure to close a €500 billion funding gap and reduce their reliance on the European Central Bank. Bankia, the recipient of an €19 billion government bailout last week, has signaled it will sell its varied holdings, which include a 5% stake in utility Iberdrola, 12% in International Airlines Group and 14% in insurer Mapfre, though it hasn't given a time frame. The new Basel III rules to be introduced next year will require banks to hold more capital against investments, creating a further incentive for banks to sell equity stakes.
But have investors overreacted to the overhang issue? Spanish stocks are trading at seven times expected 2013 earnings, already a 22% discount to their European peers; they are also trading more cheaply relative to their 10-year average than any other European stock market, according to Morgan Stanley. IAG's value, for example, has fallen nearly €900 million in three weeks, almost twice as much as Bankia's 12% stake had been worth. Despite the overhang, these situations could present buying opportunities when conditions normalize. But who knows when that might be?