Why Europe’s Rally Is Starting To Worry Investors

Cautious investors are becoming increasingly wary of the rally in Europe’s stocks, and are rushing to snap up derivatives to protect themselves in case the music stops. They’ve been buying more and more “put” options, which hedge against falling prices, while shunning “call” options, which pay out if the market goes up. That pushed the ratio of puts to calls tied to the blue-chip Euro Stoxx 50 index to its highest level in at least a decade (blue line). The index – which includes luxury goods group LVMH, chip equipment maker ASML, and industrial conglomerate Siemens – has risen 15% this year to its highest level since 2007.

And this is all happening amid mounting concerns over slowing economic growth. The eurozone economy slipped into a technical recession in June after two consecutive quarters of contraction. And analysts are expecting this earnings season to show the biggest year-over-year decline in European profits since 2020. What’s more, the services sector, which accounts for approximately 70% of the eurozone economy, is starting to slow. S&P Global’s eurozone services PMI – a key measure of activity in the services sector – fell for a second straight month in June, to record its weakest growth since January. That matters: according to a chief economist at T. Rowe Price, services PMI in the bloc has been highly correlated with European share price movements over the past three years.

Finally, poor economic data out of China this week isn’t helping matters either. See, European stocks’ outperformance this year was built on three key pillars: the avoidance of a full-blown energy crisis, the relative stability of the bloc’s banking sector, and hopes that the end of China’s lockdown measures would result in booming sales for Europe’s luxury brands. While the first two have held up, the third is looking very shaky, with recent Chinese data displaying scant evidence of any big consumer spending. Case in point: shares in European luxury goods makers LVMH and Hermés International both dropped around 4% each on Monday after a report showed China’s economic growth missed expectations last quarter, mostly because consumers cooled their spending.