Flush European Share Investors Batten Down Hatches
LONDON - European equity investors, flush from the longest run of weekly gains in seven years on hopes that central banks will act to calm the euro zone crisis and boost global growth, are looking to protect their profits in case of disappointment.
The pan-European STOXX 600 index has chalked up 10 consecutive weeks of rises, propelled to levels last seen in late March by expectations the European Central Bank, the U.S. Federal Reserve and China will step in over the coming weeks.
The rally, however, has been notable for some of the lowest trading volumes of the year, suggesting many investors are sceptical that it is based on anything more than fighting talk from policymakers.
Those who did put money on the table are sitting on gains of around 15 percent since the beginning of June, and some are aiming to shield their profits in the options market, t a king bets on increased volatility or positioning for a market fall.
Short interest on STOXX 600 - when investors borrow shares to sell in anticipation of a fall - had been on a downward trend from June. But last week it rebounded sharply, signalling more negative sentiment, according to data from Sungard Astec Analytics.
"It's very hard to make really big bets on a market that is dominated by policy and policymakers. It's not very comfortable to see a market rising on policy hopes without real macro data following," said Patrick Moonen, senior equities strategist at ING Invest Management, which holds a neutral stance on equities, although it prefers Europe to the United States.
So far, there is little evidence the rally has attracted substantial fresh money, and some of those who have bought in are already getting out. European equity funds have seen outflows for the past five weeks, according to EPFR Global.
Robert Talbut, chief investment officer at Royal London Asset Management, believes the rally "will turn out to be another false dawn".
Legal and General Investment Management reckons it is time to take profits, and Nomura's European equity mutual flow sentiment indicator is back in negative territory.
Backing the case for caution, correlations between sectors within equity markets in Europe are at their highest this year - a trend usually associated with a rise in risk aversion that over-rides individual corporate factors.
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"Markets seem to be complacent across the board. There are things to be worried about across the whole space ... and those issues don't seem to be factored very much in equity markets," said Andrew Lapthorne, head of quantitative equity strategy at Societe Generale. He says a retreat may follow, especially as companies start to guide lower for third and fourth quarter earnings.
He added that investors could consider taking advantage of relatively low implied volatility in order to buy 'put' options - the right to sell the underlying stocks at a pre-set price at a later date - to hedge their portfolios in case of a retreat.
Investors are, indeed, starting to do just that, taking advantage of the fact that the cost of a 2,400 points, August put on EuroSTOXX 50 is now a quarter of what it was a week ago.
The put/call ratio on the euro zone blue chip index has climbed to three-week highs at 1.32, and the share of puts in the open interest on the August options has risen to 58 percent from 54 percent a week ago, data from Eurex exchange shows.
Implied volatility, a measure of expected price swings, on the index is down 15 percent over the past three weeks, while the equivalent U.S. gauge, the VIX, is heading down towards levels not seen since 2008.
That in itself offers an attractive opportunity to investors wishing to position for a market retreat or simply hedge their bets before potentially market-moving events in coming weeks.
"Volatility is the thing that is most underpriced. With so many catalysts ... that's a much more attractive trade," said Gerry Fowler, global head of equity and derivative strategy at BNP Paribas. He said current levels implied daily swings of around 1.5 percent on the blue-chip EuroSTOXX 50 index, while upcoming events could trigger several moves of 4 or 5 percent.
Such events include the Fed's annual Jackson Hole conference at the end of this month, followed by ECB and Fed meetings in the first two weeks of September offer plenty of scope for policy announcements, and hence for market disappointment.
For example, the ECB has said it may help bring down borrowing costs for Spain and Italy, but only if they formally request aid. Action is also likely to depend on Germany's constitutional court approving the euro zone's permanent bailout fund, the European Stability Mechanism. The court's verdict is due on Sept. 12.
"As people come back from holidays and we approach the key dates in September, we expect to hear some of the usual rhetoric from politicians, and the market will re-assess how likely we are to get a policy response," said JPMorgan analyst Matthew Lehmann.
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