Investors return to European equity markets

Christine Lagarde (IMF) and Mario Draghi (ECB)

Exaggerated fear has been overcome

Graph and numbers from the last six months are clear: investors are coming back on the European equity market. Whereas the Nasdaq composite or the Dow Jones indices performances over the last six months are below 10% , the European equity index Euro Stoxx 50 performance during that period is close to 25% (see Fig. 1).

Clearly, the realized volatility of the European Index is still much higher than its American counterparts (28% for the EURO STOXX 50 vs 13%-15% for the American indices). One might then say: “ok, this is just a windows-measurement effect – wait a little bit and you will see the realized volatility getting back the European performance”. 

Fig 1. Euro Stoxx 50 positive bias - June/Nov 2012

Yet something else is happening here: the addition of risk in the European shares is converted into performance with a much better efficiency (conversion rate = Sharpe ratio) than it is observed for the American technology index (Nasdaq). This (Sharpe) ratio is above 2 for the European Index whereas it is close to 1 for the American technology index [Source: RaisePartner].  

Nothing lasts forever, even (market) fear

        The U.S. government figures come on top of recent China manufacturing data that shows its economic recovery is gaining momentum – Lorraine Tan, director at Standard & Poor's equity research in Singapore, declared last week “stocks have been on the upswing thanks to big-picture data pointing toward a less risky global economic environment for next year” (Asia Stocks Rise on US Data, Budget Talks Continue, ABC News-Nov 29, 2012).

      Announcement of the Federal Reserve’s QE3 are clearly diminishing (short-term) tail risks. “The Federal Reserve should continue buying long-term bonds to support economic growth until the outlook for U.S. employment gets considerably better”, Fed Board Governor Jeremy Stein said on Friday November 30^th (Fed's Stein backs QE3, says policy remains effective – Chicago Tribune).

  

      Renewed confidence in Europe's ability to tackle a debt crisis in Greece. “Indeed, we believe that the European Central Bank's bond-buying plan (OMTs), announced by Mario Draghi in September, should support the European equity markets and ease tensions in the eurozone” declared Jean-Christophe Rochat from Banque Heritage (European euphoria: the equity managers top selectors are backing, Citywire, Nov 30, 2012).

On the market observables side, volatility and even more important average realized correlation between all the components of the Industrial Dow Jones index have decreased, meaning that investors are getting back on the fundamentals and founding their decisions on analysis of economical and financial real perspectives.

Fig 2. Realized Correlations between Dow Jones components - 2012

"There's been a strong reversal in sentiment," said Marc Renaud, chief executive officer of Mandarine Gestion, which has 1.45 billion euros ($1.89 billion) in assets under management.

"The market is in a classical phase of risk-premium reduction. Now what we need is a pick-up in macro data to really start a long-term bullish trend." (Source: Reuters Fri Nov 30, 2012 1:02pm EST).

Euro Stoxx 50 components

	Supersector	Country
1	AIR LIQUIDE	Chemicals	FR
2	ALLIANZ	Insurance	DE
3	ANHEUSER-BUSCH INBEV	Food & Beverages	BE
4	ARCELORMITTAL	Basic Resources	LU
5	ASML HLDG	Technology	NL
6	ASSICURAZIONI GENERALI	Insurance	IT
7	AXA	Insurance	FR
8	BASF	Chemicals	DE
9	BAYER	Chemicals	DE
10	BCO BILBAO VIZCAYA ARGENTARIA	Banks	ES
11	BCO SANTANDER	Banks	ES
12	BMW	Automobiles & Parts	DE
13	BNP PARIBAS	Banks	FR
14	CARREFOUR	Retail	FR
15	CRH	Construction & Materials	IE
16	DAIMLER	Automobiles & Parts	DE
17	DANONE	Food & Beverages	FR
18	DEUTSCHE BANK	Banks	DE
19	DEUTSCHE TELEKOM	Telecommunications	DE
20	E.ON	Utilities	DE
21	ENEL	Utilities	IT
22	ENI	Oil & Gas	IT
23	ESSILOR INTERNATIONAL	Healthcare	FR
24	FRANCE TELECOM	Telecommunications	FR
25	GDF SUEZ	Utilities	FR
26	GRP SOCIETE GENERALE	Banks	FR
27	IBERDROLA	Utilities	ES
28	INDITEX	Retail	ES
29	ING GRP	Insurance	NL
30	INTESA SANPAOLO	Banks	IT
31	L'OREAL	Personal & Household Goods	FR
32	LVMH MOET HENNESSY	Personal & Household Goods	FR
33	MUENCHENER RUECK	Insurance	DE
34	NOKIA	Technology	FI
35	PHILIPS ELECTRONICS	Industrial Goods & Services	NL
36	REPSOL	Oil & Gas	ES
37	RWE	Utilities	DE
38	SAINT GOBAIN	Construction & Materials	FR
39	SANOFI	Healthcare	FR
40	SAP	Technology	DE
41	SCHNEIDER ELECTRIC	Industrial Goods & Services	FR
42	SIEMENS	Industrial Goods & Services	DE
43	TELEFONICA	Telecommunications	ES
44	TOTAL	Oil & Gas	FR
45	UNIBAIL-RODAMCO	Real Estate	FR
46	UNICREDIT	Banks	IT
47	UNILEVER NV	Food & Beverages	NL
48	VINCI	Construction & Materials	FR
49	VIVENDI	Media	FR
50	VOLKSWAGEN PREF	Automobiles & Parts	DE