Expect a Spanish Inquisition

 | Jun 12, 2012 | 10:30 AM EDT
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Though markets got off to a disappointing start Monday, the previous week was joyous for investors. Major U.S. equity indices climbed by more than 3% last week as China implemented a rate cut and hopes for a continued U.S. recovery got a boost from encouraging economic data. But the attention of investors continues to focus on the latest trouble zone in Europe: Spain.

A large part of last week's rally was attributable to news that Spain had accepted a bailout to help beef up its major financial institutions, theoretically staving off a run on the banks and perhaps a collapse of the country's financial system. Spanish stocks, which have been beaten down in 2012, rose sharply on the news. The iShares MSCI Spain Index Fund (EWP) was up about 10% last week, making it one of the best performers during that stretch.

Bargain hunters are no doubt continuing to pick over Europe, and recent developments in Spain might convince you to take a chance on this economy. After all, a return to beginning-of-the year levels for EWP would mean a gain of close to 25%.

But this is one temptation that should be avoided at all costs. Though the can has been kicked a bit further down the road, the Spanish economy doesn't have a prayer. It's all but certain to enter into a period of swift contraction, and it wouldn't be the least bit surprising if Spain, not Greece, ultimately drives the dissolution of the eurozone. Though Spain held on for much longer than Greece and Ireland before it, this economy will experience perhaps the most severe downturn and sudden fall.

The bearish outlook for Spain is related primarily to the dismal employment picture. The 24% jobless rate, which is the highest in Europe, is the true indication of the country's woes. And a bailout of a major bank will do nothing to change that; there will be no new jobs created as a result, and diminished flexibility for implementing plans to stimulate the labor market. Last year, I saw Spain as an opportunity, assuming that the unemployment rate had no choice but to retreat. But that notion has been disproven: Spain's unemployment rate does not bow to the laws of gravity, and may continue to rise.

Spain's consumer spending has also continued to decline severely, an indication that the austerity programs there are not working (a concession that is tough for me to make). And the acceptance of a bailout all but guarantees more of the same failed medicine; Spain has signed itself up for oversight from its lenders and even harsher austerity than it had attempted to implement on its own.

All this adds up to a dismal outlook for EWP, the only pure-play Spain exchange-traded fund available to U.S. investors. But it's not the only fund that will get battered by Spain's ongoing woes, several other ETFs with big allocations to this region figure to be hit hard as well.

It's worth doing a "Spanish Inquisition" on your portfolio. You'd be well served to minimize your exposure to this trouble spot immediately.

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