Le Stock Sportif: London Looks To Retake The Lead From Paris

What happened last week?

US

• Investors are on course to trade a record volume of options tied to the VIX volatility index.
• Spending on interest and gasoline reached its highest percentage of US disposable income in nine years.

Europe

• London stands on the verge of overtaking Paris as Europe’s biggest stock market.
• Investors are ditching Europe’s commercial property market.

Asia

• China’s manufacturing activity grew for the first time in six months.

What does all this mean?

The VIX – known as Wall Street’s “fear gauge” – shows the expected volatility in the US stock market over the next month. And options trading tied to the index is on course to hit record volumes this year, with the bulk of the increase coming from investors buying “call options” on the VIX – trades that pay off if volatility increases. And because spikes in volatility tend to align with intense market selloffs, the boom in call options suggests that investors are positioning themselves for a big dip.

Higher interest rates and rising oil prices mean financing and gasoline costs are sucking up a greater share of Americans’ disposable income – the money left over to spend or save after taxes have been deducted. Together, those costs accounted for 4.7% of US disposable income in August – the most in nine years. Increases in the proportion of income going to either interest payments or gas expenses often precede recessions, so the recent surge in both poses a double challenge for the US economy.

Less than a year after relinquishing its title as Europe’s biggest stock market to Paris, London is on the brink of taking it back. At the end of September, the combined dollar-based market capitalization of British listings sat at $2.90 trillion, closely trailing France’s $2.93 trillion, according to Bloomberg.

High interest rates have dented valuations in the European commercial property market, prompting investors to shift away from the sector and toward assets that benefit from rising rates. As a result, investments in European commercial real estate funds fell 59% in the first half of this year, compared to the same period last year. That steep drop could force funds to sell their property investments, potentially driving down prices in the property market – already posting double-digit dips – even further.

China’s official purchasing managers index (PMI) shows how the country’s manufacturing sector is doing. And in September, for the first time in six months, the reading landed above the crucial 50-mark that separates expansion from contraction, clocking in at 50.2, up from 49.7 the month before. The data renewed investor hopes that the world’s second-biggest economy is beginning to find its feet.

This week’s focus: the UK stock market

The gap between London and Paris’s stock market capitalization has narrowed steadily this year, driven by two key factors.

First is sector composition. Energy has a 14% weighting in the UK’s FTSE 100, and that sector has benefitted from a 30% surge in oil prices over the past three months. In contrast, LVMH, L’Oréal, Hermès, and Kering collectively make up almost 20% of the French CAC 40. These luxury and cosmetics firms are contending with faltering demand across Europe and in China.

Second is currency tailwinds. Expectations that the Bank of England will conclude its 22-month interest rate hiking cycle have sent the British pound lower versus the US dollar. That’s providing an earnings lift for an index that’s loaded with exporter stocks. See, FTSE 100 firms generate about 75% of their sales overseas, and the weaker the pound is, the higher the value of those foreign earnings when converted back into sterling.

If the UK does manage to reclaim its place as Europe’s biggest stock market, it would go a long way toward reversing years of post-Brexit declines that have led to a steep valuation discount, relative to its global peers. Today, based on the forward price-to-earnings ratio, the FTSE 100 trades at a 35% discount to the MSCI World Index.

The week ahead

• Monday: China loan growth (September), eurozone economic sentiment (October).
• Tuesday: Earnings: PepsiCo.
• Wednesday: Minutes of the Fed’s latest meeting.
• Thursday: UK economic growth (August), US inflation (September), minutes of the ECB’s latest meeting, China foreign direct investment (September).
• Friday: China inflation (September) and trade balance (September), eurozone industrial production (August). Earnings: BlackRock, Citigroup, JPMorgan, Wells Fargo, UnitedHealth.