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European shares’ rally pauses to catch its breath

European equities stalled yesterday, with weak economic data from the United States and concerns about the scope for more stimulus in China giving investors the excuse to lock in profits on a new year rally to multi-month highs.

The US trade deficit unexpectedly grew in November, suggesting that fourth quarter gross domestic product growth in the world’s biggest economy would likely be lower than previously expected.

The FTSEurofirst 300 index provisionally closed 0.1 per cent lower at 1,163.40 points, retreating from Thursday’s two-year peak of 1,170.29 hit on the coat tails of last-minute end-2012 US budget deal to avert steep austerity measures.

“We got some fantastic returns in the early days of this year. If we look at valuation and momentum indicator it seems like this rally is reaching the ceiling. Looking at the earnings season, we think there is more downside risk than upside risk on earnings,” Peter Garnry, strategist at Saxo Bank, said.

“If you take a tactical position around this, you would either underweight European equities or sell out. If you are really aggressive you could go short, and the (German) DAX could be a good way to do that.”

Others have also started to turn more cautious on equities, with Bank of America Merrill Lynch, Credit Suisse, Cheuvreux and Goldman Sachs all warning of a possible near-term consolidation or even correction.

“The probability of a major correction in risk markets in the first half of 2013 is rising particularly because investor sentiment has simply leapt higher in recent weeks,” BofAML’s investment strategists wrote in a note.

They recommend hedging long bets on Europe with EuroSTOXX 50 put options.

Investors have indeed been snapping up puts, which give the right to sell stocks at a pre-set price and can thus protect against market falls. The five-day average put/call ratio on the eurozone blue chip index has risen to a nine-month high of 1.61 times, according to Thomson Reuters Datastream.

Miners were the worst performing sector yesterday, off 1.7 per cent, after higher-than-expected Chinese inflation, which hit a seven-month high in December, fuelled concerns that there may be little scope left for fresh central bank stimulus in the world’s top metals consumer.

Among single stocks, Tullow Oil was one of the top fallers,losing 3.2 per cent after its output guidance for 2013 came short of expectations.

With the earnings season already in full swing in the United States and set to kick off in Europe in a week’s time, outlooks are in the spotlight.

“For next year, bottom up expectations (based on forecasts for individual stocks) are 12 per cent earnings growth and we think that’s too optimistic once again,” said Ronald Doeswijk, chief strategist at Robeco, adding that he is “not very enthusiastic about the outlook for equities”. (Reuters)

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