Europe slumps in extreme volatility

By Jamie Chisholm, Global Markets Commentator

An initial rally in European bourses has swiftly faded as traders endure another session of extreme volatility.

The FTSE Eurofirst opened with gains after it was hoped a stoic performance from some Asian bourses might have cauterised the flow of risk asset selling that has swept global markets over recent days.

But the bearish mood soon again took hold as the spectre of Wall Street’s 6.7 per cent slump overnight weighed on sentiment and traders remained worried about global growth prospects, the US rating downgrade, and eurozone fiscal concerns.

The FTSE Eurofirst 300 is now down 4.9 per cent, the All-World is off 1.9 per cent, commodities are still under pressure but “haven” bonds are losing some lustre after their recent strong run, nudging yields higher.

London’s FTSE 100 has entered “bear market” territory as its 5.4 per cent fall means it has lost more than 20 per cent since hitting its cyclical peak earlier this year. Brent crude dropped below $100 a barrel for the first time since February, but is now down 2.4 per cent at $101.20.

The extent of the market gyrations has been best illustrated by the astonishing movements in US equity futures. At about 0300 BST, the S&P 500 contract suggested New York would begin Tuesday’s session with a further 3.5 per cent drop, taking its losses over the past 12 trading days to nearly 20 per cent.

Gold spiked to a new record as traders steeled themselves for more turmoil as forced margin selling in Asia again battered stocks.

Then, slowly, and at first timidly, the buyers returned. Australia’s S&P ASX/200, which had been down 5.5 per cent, rallied to close up 1.2 per cent as “bargain hunters” moved into banks and resources groups.

The latter benefited from hopes that demand out of China for raw materials would stay relatively strong after inflation data from the People’s Republic suggested prices may have peaked, thus reducing the need for Beijing to toughen its monetary stance.

Hopes for Chinese growth may also have served to remind investors that, despite the difficulties facing many heavily indebted so-called developed nations, activity in many large emerging economies remains fairly robust.

And so, by the time Europe opened for business, the S&P futures were recording a gain of 3 per cent, a swing of more than 6 per cent. But they have since pulled back again and point to a flat open in New York. Gold has touched $1,775 an ounce for the first time and is now up 3.3 per cent to $1,773.

Action in the forex markets, however, suggests a degree of calm has returned, with the euro up 0.2 per cent to $1.4209 and bolt-holes such as the Swiss franc losing some lustre. Growth currencies like the Australian dollar, which at one point dropped below parity to its US namesake, have pared losses. The Aussie is now down just 0.2 per cent at $1.0189.

Profit-taking is occurring in the Treasury market. Despite the US downgrade, yields on benchmark 10-year Treasury yields fell past their lows of 2010 during Monday’s flight to “safety”, down 25 basis points to 2.31 per cent. On Tuesday, the benchmark yield is up 2 basis points to 2.34 per cent.

Meanwhile, the prospect of European Central Bank buying is continuing to support the eurozone debt complex, with Italian and Spanish 10-year yields down 20 basis points to 5.09 per cent and 16bp to 5 per cent, respectively.

Trading Post.

Amid the current market turmoil there will doubtless be some investors who require a sign of assistance from Tuesday’s Federal Reserve monetary policy meeting before they venture back into riskier assets.

The canny and cash rich may already be recognising opportunities amid the funk, as perhaps shown by the bounce in US futures on Tuesday morning.

The most obvious point to note is that fear is the scourge of rational analysis.

That is why the KCJ index, which gauges the degree of correlation for S&P 500 stocks, started Monday’s session above 75, versus a six month average of 60.

As the market becomes less discriminating in a slide, it throws up some juicy relative underpricing.

One area that may start catching the attention is the household sector.

Despite the US credit rating downgrade, long term Treasury yields are near multi-month lows, keeping downward pressure on mortgage rates and offering a sort of automatic stabiliser to the weaker economic environment.

The flight out of riskier assets has also hit oil prices, forcing the RBOB gasoline futures lower and easing the pressure on the pockets of US motorists. Watch consumer staples.

Additional reporting by Telis Demos in New York

Copyright The Financial Times Limited 2011