* StarMine forecasts earnings misses in Spain and Italy
* Consensus view is for more rallies on IBEX and FTSE MIB
* Weak earnings could derail bullish options bets
By Sudip Kar-Gupta
LONDON, Feb 24 Weak corporate earnings prospects in Spain and Italy, and the potential hit to their banks in the coming month from bad loans, pose a risk to market bets that shares in those countries will extend their recent rally.
Spanish and Italian equity funds are leading Europe in terms of net inflows, data from EPFR has shown, and traders and strategists said clients had bought more "call" options to bet on gains in Milan and Madrid.
Credit rating agency Moody's on Friday raised its rating on Spain, and Spanish shares are at their highest premium to the broader European market since 2007. The discount between Italian equities and Europe, meanwhile, has narrowed to its smallest in around three years, Thomson Reuters Datastream showed.
Yet Thomson Reuters StarMine's SmartEstimates, which uses forecasts from the analysts with the best track record, predicts Spanish companies will miss their earnings estimates by 3 percent this year.
StarMine also predicts that Italian firms will miss their estimates by 3.2 percent, hinting at the fragile nature of the region's economic recovery.
This is a worse outlook than for the pan-European STOXX 600 index, for which StarMine forecasts a negative earnings surprise this year of 1 percent, and partly reflects the hit to Spain and Italy from the euro zone's sovereign debt crisis of 2010-2012.
"We are optimistic that the economic recovery will take hold in the periphery over 2014, but the pace of recovery will likely be much slower than current valuations justify," said John Bilton, European investment strategist at Bank of America Merrill Lynch.
This expected earnings disappointment is mainly clustered around banks, which count for the biggest proportion of Italy's FTSE MIB and Spain's IBEX bourses and are heavily dependent on the domestic economy in both countries.
Spanish banks BBVA and Santander reported higher annual profits last month, but data in February showed bad loans had continued to rise for both Spanish and Italian banks.
ITALY - BETTER BET THAN SPAIN?
Italy's FTSE MIB equity index has risen around 8 percent since the start of 2014 and Spain's IBEX has gained around 1 percent, while the pan-European FTSEurofirst 300 index is up by around 2 percent.
Italian shares rallied further last week as investors welcomed the country's new centre-left prime minister Matteo Renzi, with Renzi promising reforms for an economy which has only just scraped back into growth.
However, StarMine data shows analysts have continued to cut earnings forecasts for Italy and Spain. The mean forecast for the next 12 months in Italy is down by 5.3 percent over the last 90 days, while the one for Spain has fallen 4.3 percent.
Spanish telecoms group Telefonica is expected to post lower revenues next week as a result of slower growth in Latin America, while analysts have highlighted Italian bank Unicredit and Spanish lenders BBVA and Santander as among the European banks most exposed to emerging markets problems.
Societe Generale's equity derivatives strategists said that given this scenario, Italy was a better bet than Spain, and backed selling IBEX "call" options in favour of bets on Milan, while HED Capital head Richard Edwards backed selling out of the recent move up in Spain and Italy.
"I would look to sell Spain and Italy on rallies," he said. (Additional reporting by Alistair Smout and Tricia Wright; Editing by Hugh Lawson)