Complacent No More: Hedging Costs Jump in Europe’s Stock MarketBy
Cost of protecting against a drop in the Euro Stoxx 50 doubles
VStoxx, CAC 40 volatility climb for 10 straight days
With less than two weeks to go before the first round of French presidential elections, investors are racing to protect gains that have pushed the region’s shares to their highest prices in more than a year.
The cost of hedging against declines in the Euro Stoxx 50 Index has surged to its highest level since the U.K. referendum on European Union membership, rebounding from near a 15-month low in just a little more than a week. Even as equities have remained stable, a gauge tracking volatility expectations has climbed for 10 straight days, the longest streak since November.
While independent Emmanuel Macron and euroskeptic Marine Le Pen are still leading in surveys ahead of the April 23 vote, far-left candidate Jean-Luc Melenchon is gaining ground, stoking concern the presidential race will prove to be a close one. After last year’s unexpected Brexit and Donald Trump wins, investors want to ensure they won’t be caught off guard once again, according to EFG Asset Management’s Daniel Murray.
“The polls have become less reliable, and that perception is weighing on market sentiment,” said Murray, London-based head of research at EFG, which oversees about $20 billion. “As we approach the date, the mind focuses more on the possibility of Le Pen being elected. Even though it’s slim, it’s non-zero.”
Traders are also seeking to hedge gains as the earnings season is about to take off and as speculation of a reduction in European Central Bank stimulus is beginning to surface amid an improving economy, Murray said. The Euro Stoxx 50 has climbed 5.5 percent this year, taking its valuation to 14.4 times estimated earnings -- higher than its five-year average.
The difference in the price of options protecting against a 10 percent drop in the European index over contracts betting on a similar increase has almost doubled this month, posting its steepest jump since December 2014. April futures on the VStoxx Index, a gauge tracking the cost of Euro Stoxx 50 options, now trade about 30 percent above May contracts, indicating that investors are paying up to hedge against equity swings in the near term.
Looking more specifically at France’s CAC 40 Index, a measure of volatility expectations for the stock gauge has risen for 10 consecutive days, the longest streak since August 2011. As investors boost bets, the number of CAC 40 options outstanding has surged to its highest since December 2010.
While political uncertainty is a key sentiment driver, a more fundamental issue has the potential to upset this year’s market rally. Investors will soon start focusing on corporate earnings, with companies from Unilever to Deutsche Bank AG reporting later this month. Analysts, who project profits at Euro Stoxx 50 companies will grow 9.5 percent in 2017, may be too optimistic, according to HSBC Holdings Plc.
“Earnings are depressed, but we think a hoped-for strong rebound is unlikely,” HSBC strategists led by Ben Laidler wrote in a report last week. “And without it, European equities are not cheap.”