Markets Rally Amid Falling Volatility and Optimism in European Stocks
Political unrest in Europe may have dominated headlines, but the market narrative is shifting quickly. Investors are shrugging off concerns, such as the budget disputes in France, and focusing on the year-end rally. Taking a contrarian stance in this climate appears increasingly risky.
Market indicators suggest growing optimism. Volatility is dropping at a rapid pace, French equities are recovering as traders unwind short positions, and Germany's DAX Index continues to break records. The Stoxx 600 has enjoyed a seven-session winning streak, the longest since May, with strength spreading across multiple sectors. Despite the rising momentum, the market has not yet reached an overly exuberant phase.
Barclays strategists, led by Emmanuel Cau, attribute the positive sentiment to favorable economic data and a diminished influence of Trump-era policies on rates and the dollar. They argue that the path of least resistance remains upward, particularly in Europe, where a long-overdue catch-up rally appears to be underway.
France's CAC 40 has rebounded by 4% since its late-November lows, even as political uncertainty persists following the government's collapse. Traders are reducing bearish positions, suggesting that the worst-case scenario may already be priced into the market. While the medium-term outlook remains challenging, the rally could extend further on expectations that a budget compromise might be reached.
European volatility has been on a steep decline. Although still higher than in the US, the gap between the US-based VIX and Europe's VSTOXX has nearly closed. This diminishing spread underscores the waning tension in European markets.
Investors continue to show confidence in Europe, with German equities leading the charge. The DAX Index's 10-day rate of change (ROC) has surged past 6%. Although this has occurred 61 times in the past four years, the current environment is unique. In previous instances, volatility was either significantly higher or its decline during market rallies was much steeper.
The intensity of the current rally has surprised many. It deviates from the conventional pattern of gradual upward movement followed by sharp declines. Instead, the market seems to be chasing gains with unusual fervor, reflecting an environment where the upside is pursued with near-desperation.
The European Central Bank (ECB) plays a pivotal role in bolstering market sentiment. Investors trust the institution's ability to implement the rate cuts necessary to support the eurozone's struggling economy. This week's policy meeting is widely expected to deliver another reduction, with markets anticipating continued easing through mid-2025. By then, the ECB's deposit rate could drop to 2%, reinforcing a favorable monetary environment.
Mark Haefele, Chief Investment Officer at UBS Global Wealth Management, emphasizes the ECB's significance in shaping the outlook for European equities. He notes that while the eurozone's economic conditions remain tough, the ECB's accommodative stance provides a supportive backdrop for stocks, particularly given their relatively attractive valuations.
This combination of factors—declining volatility, strong performance in key indices, and a reliable monetary policy framework—has positioned European markets for further gains. Despite lingering uncertainties, the focus remains on growth, recovery, and the opportunities ahead.