Greece is front and centre in Europe at the moment, despite representing only two per cent of the eurozone’s total output.
Now that markets are consoling themselves that a flawed solution to the Greek problem is likely, investors' attention should turn to the bigger siblings, Italy and Spain, and their ability to drive growth in the region.
Spain
The Spanish economy grew at nearly four per cent in the first three months of the year on an annualised basis, nearly twice the rate of the eurozone as a whole.
This economic momentum is reflected in the upward revision to consensus growth forecasts and we could well be seeing the start of a strong cyclical recovery supported by both internal and external demand.
Even the beleaguered Spanish real estate market has shown some green shoots.
Real estate prices turned positive last summer and the number of mortgages and housing permits have reached levels not seen since 2006.
Even so there remain structural economic issues that need to be corrected.
Unemployment is still rampant especially among those under 25 – youth unemployment is over 50 per cent.
If Spain can’t get a handle on its employment situation through necessary reforms then that internal demand might not be strong enough to sustain the country’s predicted recovery.
Political stability is a key ingredient to the reform program.
Recent Spanish regional election results weakened the two-party system in the country while affirming a surge in support for new parties, both of which are opposed to fiscal austerity and less supportive of structural reforms.
However, the most radical, Podemos, has seen declining support in recent months and perhaps voters are fearful of going through the same experience as Greece.
The IBEX 35 has climbed 12 per cent year to date when dividends are included, but the headline figure masks a significant spread in performance between the best-performing (IT and consumer discretionary) and the worst-performing (financials and energy) sectors.
Earnings estimates have been revised upward along with the growth numbers and analysts’ expectations are for earning growth close to 20 per cent over the coming 12 months – a lofty expectation for any market to meet.
Italy
Aside from Greece, Italy has been the laggard on economic growth, dipping back into recession in 2014, but more recently has provided reasons for cautious optimism.
Business surveys, such as the PMI index have been trending higher all year an d the consumer is spending again on big ticket items.
New car registrations were up 14.4 per cent year-on-year in June and have been increasing at a rate of over 10 per cent since January.
More encouraging than this short-term economic improvement are the long-term structural changes being pursued by Prime Minister Matteo Renzi, who continues to drive an ambitious program of reforms to streamline governmental decision-making, cut unemployment and improve the competitiveness of the economy.
The most important reforms taken recently include the Jobs Act to reform the labour market and the Italicum – a new electoral law that should increase the tenure of governments and reduce political instability.
While progress is slower than many would like, Prime Minister Renzi has achieved more than any of his recent predecessors and he continues to move in the right direction.
With a gain of 25 per cent this year, the Italian equity market has been one of Europe’s strongest performers, beaten only by Ireland.
But the FTSE MIB index remains 45 per cent below its 2007 peak and still offers interesting opportunities for investors who want exposure to an economy that is not only enjoying a long-awaited economic upturn but, hopefully, a major period of structural reform.
The Italian equity market has traditionally been held back by the large number of family-owned companies, who were reluctant to relinquish control, but improving corporate governance could make the Italian equity market more attractive.
Now that the smallest child seems to have stopped misbehaving, investors' focus should return to the robust economic momentum and reform progress in the rest of the region to support asset prices.
However, the abundance of good news for Europe and its economy over the past year has rightly boosted expectations for both output and earnings growth, a lot of which is being reflected in valuations.
This means investment in eurozone equities should be much more selective towards the market, favouring domestically orientated cyclical sectors.
Kerry Craig is a global market strategist for JP Morgan Asset Management.
