Best of Times Turn Sour as Europe Quarterly Stock Gains Fade

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As global investors sped into Europe’s rally at the end of March, Rupal Bhansali was switching gears.

Concerned bullishness on exporters was too rampant, the chief investment officer of international and global equities at Ariel Investments LLC took profits on the highest-flying stocks and sought safety in defensive equities. It’s a decision others wish they’d made after the events of the last two months.

Anyone lured to Europe after the easy money policies of Mario Draghi has been bathed in volatility for months, most recently as Greece’s bailout broke down. Swings in the Stoxx Europe 600 Index reached the highest in three years as practically everything that wasn’t a phone company or a household-goods maker dropped.

“When people overexpose themselves to something and the momentum is building to the point where it becomes a crowded trade, usually the opportunity is somewhere far away,” Bhansali, who helps oversee $2.6 billion at Ariel Investments, said by phone from New York.

Her international fund outperformed 79 percent of its peers this year, according to data compiled by Bloomberg.

After climbing 21 percent to a record in April, the Stoxx 600 has pared its annual gain to 11 percent, ending June at a four-month low. Intraday swings in the Stoxx 600 averaged 0.8 percent daily in the first half of 2015, and the VStoxx Index, which tracks volatility expectations, surged 23 percent to a three-year high.

The Stoxx 600 climbed 0.5 percent at 9:23 a.m. in London.

Euro, Bonds

First it was a rebound the euro and the bond selloff. Then it was wrangling over Greece that helped send the Stoxx 600 down. It lost 4.6 percent in June, the most in two years.

Greece’s ASE Index, down 3.5 percent in 2015, has been closed since Monday as the country shut its banks and imposed capital controls to shore up its financial system. Negotiations fell apart after Prime Minister Alexis Tsipras called for a referendum on austerity demands over the weekend.

Germany’s DAX Index, which was among the biggest gainers in the first quarter, became the worst-performing developed market in the second with an 8.5 percent plunge. Automakers and chemical companies, leaders at the start of the year, were some of the biggest losers in the past three months.

Real estate and insurance stocks also fared poorly as bond yields rose, reducing demand for dividend-paying stocks.

Record Inflows

All along, an exchange-traded fund tracking European equities while hedging against euro fluctuations kept attracting investors. They poured more than $4 billion in the WisdomTree Europe Hedged Equity Fund in the second quarter, after a record $10 billion inflows in the first.

With the Greek vote coming up on July 5, the Federal Reserve poised to start raising interest rates and Chinese shares plunging into a bear market last month, there may be more volatility ahead, according to Quoniam Asset Management GmbH’s Soeren Steinert.

“This is the most uncertain second half of the year in a long time,” said Steinert, who helps manage $24 billion as associate director for equities trading at Quoniam in Frankfurt. “You don’t know what’s going on with the macroeconomics in Europe, U.S., what will happen with Greece.”

Yet most investors and strategists remain confident that the region’s stock rally has more to go. Economists forecast gross domestic product in the euro area will expand 1.5 percent this year, helped by European Central Bank stimulus, and analysts estimate earnings at Stoxx 600 companies will climb 6.5 percent in 2015 and more than 12 percent in the next two years.

Options trading indicates investors see stock-market volatility fading later this year. The cost of hedging against Euro Stoxx 50 Index swings in the next three months is is at the lowest level since 2011 relative to one-month contracts.

“We expect downward pressure to resume with this new twist in the Greek saga, but it may be short lived,” said Lorne Baring, managing director of B Capital SA, a Geneva-based asset manager. “The threat to the euro zone is perceived as being much less than in 2011, when the region was much more fragile.”

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