The world’s stock markets are increasingly interrelated. The psychology of traders, which drives most short-term price action, is continuously shaped by the nonstop torrents of global news flow. So even Americans can no longer afford to ignore what is going on in overseas markets. And the influence of European stock markets in particular is large and growing, making their recovery well worth watching.
Out of all foreign markets, the major European ones easily have the biggest impact on the US stock markets. This makes a lot of sense for a couple reasons. Europe’s crisis of confidence ignited by its excessive government spending has made it the primary focus of worry in the past couple years. The profligate European countries’ sovereign-debt woes have increasingly 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 US markets open. So in those critical couple of hours before the US open, which often set the tone of our entire trading day, futures traders carefully consider and react to European developments. Then the final couple hours of European trading overlap initial US trading, cementing Europe’s influence.
This is particularly potent for sparking US selloffs, as fear is a contagious universal motivator. We just saw a great example. March 6 was the biggest down day of this year by far for the American flagship S&P 500 stock index, it lost 1.5%. Why? Over in Europe that day, fears that Greece would fail to reach an agreement with enough of its private bondholders led to big losses of 3.0% and 3.6% in the German and French stock markets.
If you analyze big down days in the US markets since the stock panic, a major fraction are sparked by weakness in major European stock markets. So as American speculators and investors, we can no longer ignore what is happening in Europe. Watching its key markets helps us better understand why our local ones are moving a certain way on some of the most volatile trading days, both down and up.
The big three European stock markets are found in Germany, France, and the United Kingdom. In 2010, these powerhouses represented 20.4%, 17.0%, and 13.8% of total European GDP respectively. In population terms, they weigh in at 16.3%, 13.1%, and 12.4%. With Europe’s top-three countries collectively commanding over half of total European economic activity and over 4/10ths of the EU’s people, their major stock indexes well represent European stock markets as a whole.
Germany’s flagship stock index is the Deutscher Aktien IndeX (DAX, pronounced “dacks”), 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 US Dow 30 it uses far-superior market-capitalization weighting (like the S&P 500). Its base value of 1000 started in 1987.
France’s equivalent is known as the Cotation Assistée en Continu 40 (CAC, “cack”), which means “continuous assisted quotation.” It tracks the 40 most-significant French companies out of the 100 highest market caps trading on the Paris stock exchange. This CAC 40 is also market-capitalization weighted, and about half of the shares of its component companies are owned by foreign investors.
Finally the United Kingdom’s flagship stock index is called the FTSE 100 (“footsie”), 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 over 4/5ths of the entire market capitalization of that whole exchange.
Looking at these three dominant European stock indexes compared to the US’s leading S&P 500 (SPX) offers many valuable insights. Since European trading activity can heavily influence US trading, the state of Europe’s stock recovery is very important to American speculators and investors in the coming months. All four of these elite indexes are shown in these charts, re-indexed to common bases so their percentage moves are perfectly comparable. We’ll start with the past for some essential context.
Not surprisingly in this hyper-interconnected Information Age, the European stock markets weathered the same cyclical stock bear from mid-2007 to early 2009 that ours did here in the States. For this chart, they are all indexed off the preceding SPX cyclical bull’s top in October 2007. While the UK’s performance was a bit better and France’s a bit worse, all these lines are essentially interchangeable. One could easily be passed off for the others and few would be the wiser.