From the July 01, 2012 issue of Futures Magazine • Subscribe!

Trading in Europe’s wake

The world’s stock markets increasingly are interrelated, and trader expectations, which drive most short-term price action, are shaped continuously by the nonstop torrent of global news flow. Americans no longer can afford to ignore what is going on in overseas markets.

Out of all foreign markets, major European indexes easily have the biggest impact on U.S. share prices. Europe’s crisis of confidence, ignited by its excessive government spending, has made it the primary focus of worry in recent years. Profligate European countries’ sovereign-debt woes increasingly have dominated traders’ attention.

But over the long run, geography is even more important. As the world rotates, the European markets are the last to experience the trading day before the U.S. markets open. Those critical couple of hours often set the tone of the U.S. trading day, highlighted first by futures traders who react to European news before U.S. cash markets open.

This is particularly true for sparking U.S. sell offs; fear is a contagious motivator. We saw a great example on March 6, one of the biggest down days of the year for the American flagship S&P 500 stock index, which lost 1.5%. The impetus was fear that Greece would fail to reach an agreement with its private bondholders. European stocks were reeling, with the German market down 3% and the French market down 3.6%.

Reviewing performance since 2010, a major percentage of big down days in U.S. stocks is preceded by weakness in major European indexes. American speculators cannot ignore what is happening in Europe. 

European players

The big three European stock markets are in Germany, France and the United Kingdom. In 2010, these powerhouses represented 20.4%, 17.0% and 13.8% of total European gross domestic product, respectively. In population terms, they weigh in at 16.3%, 13.1% and 12.4%. 

Germany’s flagship stock index is the Deutscher Aktien Index (DAX), which has the unimaginative utilitarian translation of “German stock index.” It represents the 30 largest German companies in terms of market capitalization and trading volume, but unlike the U.S. Dow Jones Industrial Average, it uses market-capitalization weighting (like the S&P 500). It began in 1987 with a base value of 1000.

France’s equivalent is known as the Cotation Assistée en Continu (CAC) 40, which means “continuous assisted quotation.” It tracks the 40 most significant French companies out of the 100 highest market capitalizations trading on the Paris stock exchange. The CAC 40 also is market-cap weighted, with about half of the shares of its component companies owned by foreign investors.

The United Kingdom’s flagship stock index is called the Financial Times Stock Exchange (FTSE), an acronym derived from its two parent companies, the Financial Times and the London Stock Exchange. Its components are the 100 largest companies in market-cap terms listed on the London Stock Exchange. These behemoths collectively represent more than four-fifths of the entire market capitalization of the exchange.

Comparing these dominant European stock indexes to the S&P 500 (SPX) offers many valuable insights. By examining recent long-term trends, we’ll see how these relationships work. In all accompanying charts, the markets are re-indexed to a common base of 100 where indicated so their fluctuations are comparable.

The Euro Stoxx 50, a compilation of the 50 largest companies in the Eurozone, has taken over as the Eurozone benchmark equity index and several of its components are included in these older European indexes. 

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