European shares surged to fresh four-and-a-half year highs yesterday as upbeat corporate updates, including from insurer Generali, and US economic data gave new impetus to the rally.
Europe’s third-largest insurance firm, Generali, led gainers, rising 9.4 per cent in volume over three times its 90-day average, after announcing plans to clean up its balance sheet to restore its profitability.
Salt miner K+S AG also rallied after raising its yearly outlook while telecom gear makers Ericsson and Alcatel-Lucent were boosted by the prospect of hefty mobile technology investments in China.
They helped the FTSEurofirst 300 index of blue chip European shares rise 1.2 per cent to 1,207.83 points – a level not seen since August 2008.
The index extended gains after lower-than-expected weekly US jobless claims provided new evidence the world’s largest economy is recovering.
Separate US data pointing to a lack of price pressure was seen as giving the Federal Reserve scope to maintain its very easy monetary policy.
Despite the market’s heady levels, Robert Farago, head of asset allocation at Schroders Private Banking, was holding on to his “overweight” positions in shares, betting that a global economic improvement would boost the asset class further in the coming months.
“We’re not upping risk at this point but if we were to get new money in, would we put it into equities? Yes, we would,” Farago said.
While Farago was positive on equities in the long term, he cautioned a correction could be around the corner after the recent, steep rise, especially if worries such as Italy’s debt crisis resurface.
For this reason he was adding to his allocation to funds invested in volatility, a hedge on cash equities based on option contracts.
The cost of options on eurozone shares, as measured by the Euro STOXX 50 Volatility index, or VSTOXX, fell 10.9 per cent to close near a five-year lows yesterday.
The underlying Euro STOXX 50 index of eurozone blue chips rose 1.5 per cent to 2,744.70 points.
The VSTOXX extended a 43 per cent tumble in the past two weeks on growing expectations of an improvement in the global economy, which has led hedge funds to increase their “short” positions on volatility and long positions on equities, according to Societe Generale data
Vincent Cassot, head of equity derivatives strategy at Soc Gen, said investors were short-selling VSTOXX futures on expectations they would keep falling as they get closer to their expiry date .
Short sellers borrow a security and sell it, betting its price would fall by the time they have to return it to the lender.
Volatility future contracts tend to lose value as they approach maturity barring a spike in volatility. However, contracts tend to cost more further into the future because uncertainty is higher.
“It’s seen as an easy game (because) the level of the futures is rising with the maturity,” Cassot said.
“It costs to be long while you make profits when you’re short but being short is much more risky in case of vol spike.”