* Europe stocks half way through expected 5 pct fall
* German stocks most vulnerable after 2012 outperformance
* Tensions in Italy, Spain trigger pullback
* Sentiment indicators, U.S. data send warning signs
* Charts show buying momentum is fading
By Francesco Canepa
LONDON, Feb 7 An eight-month European stock
rally that stumbled this week faces only a temporary, shallow
pullback and central bank stimulus should ensure gains later in
Political uncertainty in Spain and Italy led to the biggest
daily index drop this year on Monday. Some national indexes have
already given up all of 2013's gains.
Monday's fall of around 2 percent and caution over U.S.
growth have left many betting on a further drop of 3-8 percent
over the next month, with Germany's blue-chip index looking
"Tactically we just feel the market has got a little bit
ahead of itself. All the sentiment indicators are now in
overbought territory and the economic numbers... are just not in
line with the valuations," Wouter Sturkenboom, investment
strategist at Russell Investments, said.
The MSCI Europe index has pulled back in the past
week, as soft corporate earnings halted a 24 percent rally since
June that had been fuelled by central bank stimulus measures
driving investors out of bonds and into shares.
Strukenboom said he would wait for European shares to fall 5
to 10 percent and for valuation on MSCI Europe to ease back to
roughly 10.5 times its expected earnings, from a three-year high
of 11.8 currently, before considering adding to his positions.
Strategists highlighted the fact that Citigroup's U.S.
Economic Surprise Indicator had turned negative. This has
historically heralded a pullback in the U.S. Standard & Poor's
500 index, with European stocks often following.
With Germany's Dax index heavily exposed to the
U.S. economic cycle through global companies such as industrial
conglomerate Siemens and car maker VW,
it was seen as the most likely target of profit takers.
"The Dax has as much exposure to global growth as it does to
European-centric issues," said Kokou Agbo-Bloua, European head
of equity and derivative strategy at BNP Paribas.
He recommended buying options to hedge for a 5 percent fall
on the Dax by March, and there were signs of investors already
putting such sentiment into practice.
Investors held 57 percent more options to sell the Dax than
to buy it as of Thursday, double the ratio on the euro zone
blue-chip Euro STOXX 50 index, Eurex data showed.
The Dax outpaced all major European indexes in 2012 with a
29 percent rise but it has been the second-worst performer after
Spain's Ibex so far this year, in a further sign
investors are starting to grow more cautious on German stocks.
"We've gone from very depressed levels of sentiment last
summer to quite exuberant or complacent sentiment. That's
normally not a bad time to be moving to the sidelines," said
Stewart Richardson, chief investment officer at RMG Wealth
Management, who began taking profit on his equity holdings in
He forecast a 5 to 7 percent fall on major stock indexes in
the next five to six weeks as overly exuberant invertors came to
terms with still weak economic data.
BNP Paribas's Love-Panic indicator, which aggregates other
sentiment indexes to spot excessive euphoria and pessimism,
showed investors were at their most positive since March 2012.
This high level of optimism, tested twice since 2011 and
each time followed by a fall in equities, created the conditions
for negative average returns of minus 11 percent for European
shares over the next six months, the bank said.
The Love-Panic indicator has a 72 percent average
correlation with equity returns, with depressed sentiment
correlating with positive forward market returns and vice versa.
Technical charts on the Euro STOXX 50 and the broader Euro
STOXX indexes also showed both were heading for a
Momentum indicators such as the Relative Strength Index,
which measures the strength of price changes relative to prior
moves, have been falling even when the index was rising,
creating what analysts call a "bearish divergence".
"We have bearish divergences in many indexes, so there are
arguments to play a correction," said Ouri Mimran, technical
strategist at Natixis in Paris.
He said the Euro STOXX 50 could fall up to 1.5 percent from
current levels to 2,588 points, a 23.6 percent retracement of
the rally started in June.
Mimran said the longer-term trend was intact, a view shared
by many fund managers, who are waiting for the near-term pull
back as an opportunity to re-enter the market at cheaper levels.
"Our more cautious view is for the next couple months,"
RMG's Richardson said. "If you were to take a longer term view,
you'd be putting them into equities over the next 5 to 10