Spanish and Italian stocks are red hotAugust 20, 2012: 12:44 PM ET
Spain and Italy have been a major source of concern for global investors, but you wouldn't know it from the stock markets in those countries.
Monday was a down day for most European markets, but stocks have been rising across the continent since European Central Bank president Mario Draghi made his now-infamous remark that the ECB will do "whatever it takes to preserve the euro" late last month.
Since Draghi uttered those words on July 26, the IBEX 35 in Spain has gained 17%, while Italy's FTSE Milano Italia Borsa is up 13%.
But while Spanish and Italian stocks still trade at significant discounts to other European companies, the rally is unlikely to last, according to John Higgins, senior economist at Capital Economics.
"If, as we suspect, the ECB fails to prevent a renewed rise in long-term borrowing costs in Spain and Italy, equity prices in both countries could therefore swiftly plummet again," Higgins wrote in a recent note to clients.
Investors are hoping Draghi will announce more detailed plans to support Spain and Italy in the bond market when top ECB officials meet on Sept. 6, said Nick Stamenkovic, market strategist at RIA Capital Markets. And Draghi's comments have helped drive down borrowing costs for Spain and Italy. The yield on Spain's 10-year bond is currently 6.3%, down from 6.9% on the day of Draghi's speech. Italian 10-year bond yields have fallen to 5.8% from 6.4%.
Stamenkovic said investors were not prepared for Draghi's remarks last month. He think the recent stock rallies in Spain and Italy were driven partly by short-covering, which occurs when investors reverse bets that stocks will fall. But for Italian and Spanish stocks to climb further, the ECB will need to back up its tough talk with action.
"The bottom line is that the market is expecting the ECB, when it next meets, to announce significant policy measures to help sovereigns," said Stamenkovic.
At the last governing council meeting on Aug. 2, Draghi indicated that the central bank would not buy government bonds unless the government in question formally asked the eurozone bailout fund to purchase bonds along side the ECB. But Draghi also said the ECB is working on the details of a plan to buy the short-term bonds of any country that asks for support from either the European Financial Stability Facility or European Stability Mechanism.
Spain is seen as the most likely candidate to take the ECB up on this offer, but Madrid has yet to make a formal request for support from the EFSF, which is currently the only option until the ESM is approved by the German Constitutional Court.
"There are many obstacles still to jump - in terms of complex decision making across the ECB, within the Spanish government, and between European finance ministers," said Andrew Milligan, head of global strategy at Standard Life Investments in Edinburgh. "But the rally could last longer if the ECB program starts to become more concrete."