Investors are hedging against a decline in the European stock market

Cautious investors are buying derivatives that would protect them if the rally in European stocks falters this year, a sign of growing concerns that slowing economic growth will weigh on markets near record highs.

Traders have been buying an increasing number of puts, which provide insurance against falling prices, versus calls, which pay out if the market goes up. In doing so, they betray an underlying nervousness about European stocks despite their recent run, Bank of America analysts said.

The ratio of puts to calls tied to the blue-chip Euro Stoxx 50 benchmark hit its highest level in BofA data in a decade.

The index, which includes luxury goods group LVMH, chip equipment maker ASML and industrial conglomerate Siemens, has risen 14% since January to its highest level since 2007. The zone’s economy Euro sank into a mild technical recession in June after two consecutive quarters of contraction.

Basically were still in a place where [Europes] the growth outlook is not surprising, said Abhinandan Deb, head of global multi-asset quantitative investment strategy at BofA Global Research. People are uncomfortably long [Europe]. They are long because they need to participate, but the core belief is not there. No one wants to chase this market so close to its peak.

Alexandru Bohotin, head of European index options trading at Optiver in Amsterdam, said he has seen greater demand for downside protection from investors in European equities, especially as investors have started to shift back into equities after being underweight most of the year. They hedge their portfolios by buying puts, which drives up metrics like put-to-call ratios, Bohotin said.

Other investors point to a recent slowdown in activity in Europe’s hitherto resilient services sector also boding badly for local stock markets.

The S&P Globals Eurozone Services Purchasing Managers Index, a measure of activity in services, fell for a second straight month in June to 52, indicating continued expansion, albeit at the slowest pace. slower since January.

Slowing service sector momentum could soon start to weigh on European equities, which have pushed higher so far this year, defying the expectations of many investors, even as the European Central Bank raised interest rates. interest at unprecedented speed to fight inflation.

Services account for around 70% of economic activity in the Eurozone, with the services PMI index considered a strong leading indicator of stock price performance due to its high correlation with services activity.

The entire rebound in stock prices in Europe after last winter is due to this rebound in services. People thought and still think the economy remains resilient, said Tomasz Wieladek, chief economist for Europe at T Rowe Price.

However, [services PMI] will likely come down significantly as part of the natural cycle of monetary policy tightening and that is something markets are not prepared for, he said, adding that the eurozone services PMI has been strongly correlated to movements in European stock prices over the past three years.

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