.
Spanish, Italian and Greek share prices recovered sharply in January, after a dismal 2010 on concerns over sovereign debt problems, with analysts saying Italy offers the safest bet of these euro zone peripherals.
Concerns over higher inflation in booming emerging markets, cheap valuations and tentative signs of stability in the euro zone sovereign debt crisis have led investors to pick up shares in Italy, Spain and Greece.
"We are heading south," said Stephane Toullieux, chief executive at Financiere de l'Echiquier, which has 5 bln euros under management and which has invested in the rally among peripherals. "The market as a whole is now saying: because of government problems — debt, deficits — you should avoid southern Europe … but we see outstanding companies in southern Europe."
Investors who were concerned the debt crisis could spread from bailed-out Greece and Ireland to Portugal and Spain sold the euro, peripheral government bonds and equities issued by those countries last year.
Italian, Spanish and Greek blue-chips have risen 10 to 12% so far this month, outperforming a 2.4% rise in the benchmark STOXX Europe 600 index and a 3.6% gain in Germany's DAX.
Last year the three markets lost 13 to 36%, while the STOXX Europe 600 advanced nearly 9% and the DAX rose 16%.
Another sign of improving sentiment in the euro zone, the euro has advanced 2.6% against the dollar after losing 6.6% last year.
Yields on 10-year Spanish government bonds over benchmark German Bunds have tightened about 35 basis points this month.
BANKING ON ITALY
"We prefer Italy to Spain. They both tend to move with the sovereign risk trade. What we found last year was that Italy, and partly France, tended to move with the peripheries," said Karen Olney, equity strategist at UBS.
"If there is a rally, I would rather play Italy and France because they have well capitalised banks. They don't have the same sovereign debt issues, so they are the safer way to play the rally."
France's CAC 40 also underperformed the broader European market last year, down 3.3%.
Credit Suisse's private bank this week upgraded Italy to "neutral" from "underweight", and maintained a "neutral" rating on Spain.
Spain's IBEX 35 carries a 12-month forward price-to-earnings of 10.4 times versus a 10-year average of 13.3 and the STOXX Europe 600's 11, Thomson Reuters Datastream shows.
Italy's FTSE MIB has a 12-month forward P/E of 10.3 times, while the CAC 40 has a forward P/E of 10.4 times.
"The rally is not built on very sound foundations. It will very much depend on how much of the growth from core Europe is spilling over to the peripheral countries," said Lothar Mentel, chief investment officer at Octupus Investment.
"With Greece it is a high-risk strategy — you have to have nerve to bet on that — not so much with Spain."
Predicted earnings surprise — a measure which weights analyst result estimates according to their track records — suggests that northern countries offer an average 0.5% earnings upside in 2011, Thomson Reuters StarMine data shows.
This compares with a 4% drop for the peripheral economies, a figure that is inflated by an expected 22% drop in earnings for Greek stocks in the ongoing year.
