Growing concerns about political issues in Italy, Spain and UK contributed to the increase in market volatility in European equity markets last month. Bond markets in Europe also sold off as short-dated bond yields increased significantly reflecting investors’ doubts on the ability for some European countries to meet their massive debt payments.
While European equity markets have been posting strong returns and enjoyed low levels of volatility for a while, the Intech Equity Market Stress MonitorTM has been suggesting that European markets are showing more signs of instability than other equity markets for quite a while. Collectively, the Intech® risk indicators reflect an increased potential for heightened volatility in European equity markets, as four of five indicators are at extreme levels.
For example, the skewness of returns measured on the European market ranks one of the highest amongst the other 21 regions we monitor, reflecting the ongoing investors’ extreme optimism on European equity markets.
Skewness of Returns
Percentile ranks for the period ended May 31, 2018
The capital concentration in Europe has also reached very low levels versus history as capital has been flowing into the smaller and more risky European stocks for a while, a sharp contrast with what can be observed in the U.S. where mega cap stocks are leading the market.
Capital Concentration
Percentile ranks for the period ended May 31, 2018
While signs of bullishness and risk taking may reflect and contribute to a stronger economy, it should also raise concerns when optimism and risk appetite reached extreme levels. In fact, the Intech Equity Market Stress Monitor™ is designed to identify how stretched a market is even if traditional indicators are pointing to positive news. Extreme ranking in our risk metrics (positive or negative) should be interpreted as signs of stress in the market and as a warning that a return to the norm may shock the market and be a source of volatility.
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