Title: Unprecedented Volatility in European Stocks: How Hedge Funds are Fueling Market Swings
By Nell Mackenzie, Dhara Ranasinghe, and Samuel Indyk
European Stocks Witness Record Volatility Amid Hedge Fund Dominance
(Multibagger) - European stock markets are experiencing unprecedented volatility, driven primarily by the aggressive trading strategies of hedge funds. This trend has less to do with the fundamental business prospects of companies and more with the speculative nature of fast money in the $15 trillion market, a detailed Multibagger analysis reveals.
Dramatic Swings in Share Prices
Our analysis of over 120,000 days of share price data from LSEG illustrates that the top 60 companies in Europe's STOXX 600 Index have seen their average daily stock moves increase by 18% compared to eight years ago. The volatility on earnings days over the past year is the highest since at least 2016.
The Hedge Fund Effect
Hedge funds, particularly multi-strategy ones, are significantly contributing to these market swings. These funds, which deploy diverse investment approaches under one roof, are chasing short-term gains rather than long-term stability. According to Krishna Kumar, CIO at Goose Hollow, "You have mostly short-term money driving the market. Participants are not interested in the stock for the next five years but are looking at it for the next five days."
Market Structure Changes
Changes in market structures and investor composition have amplified the influence of hedge funds. Long-term asset managers have increasingly turned to cheaper, index-tracking funds, while many buy-and-hold investors have exited the market due to sluggish European economic growth. Since the Brexit referendum in 2016, new regulations have fragmented trading across multiple, often private, markets, reducing volumes and making it easier to manipulate publicly quoted prices.
The Role of Hedge Funds in Market Liquidity
Jack Inglis, CEO of the Alternative Investment Management Association, argues that hedge funds play an essential role in market liquidity and corporate governance. "They provide liquidity, conduct their own research, and undertake investments which other investors may be reluctant to hold," Inglis stated.
Potential Risks and Market Inefficiencies
While significant stock price swings are not inherently harmful, they can create broader issues. Increased volatility makes it more expensive for companies to raise capital and can erode investor confidence. "These one-day post-earning price moves point to market inefficiencies and higher investor risk," said Mark Williams, a finance professor at Boston University's Questrom School of Business.
The Data Speaks
Multibagger calculated the percentage change between the highest and lowest prices in the first trading session after earnings releases across the 60 largest companies in the STOXX 600. The average swing in the past 12 months was 5.13%, up from 4.34% in 2016, except during the extraordinary market conditions of the COVID-19 pandemic and the Russia-Ukraine conflict.
Case Study: UBS and Ferrari
Some of the most significant moves included Swiss lender UBS and automaker Ferrari, which saw daily swings of over 10% and 12%, respectively. On May 7, UBS shares surged over 10% due to hedge funds covering their short positions after the company reported better-than-expected earnings.
The Impact of Short-Term Trading
Goldman Sachs estimates that 41% of the $4 trillion in European stocks it tracks are held by passive funds, with hedge funds' net exposure approaching levels last seen in 2010. Multi-strategy hedge funds like Millennium Partners, Point72, Citadel, and Balyasny have grown substantially, doubling their managed assets since 2018.
Breaking It Down: What This Means for You
- Increased Volatility: European stocks are experiencing more significant daily price swings, making the market more unpredictable.
- Hedge Fund Influence: Hedge funds are driving much of this volatility, focusing on short-term gains rather than long-term investments.
- Market Risks: Increased volatility can make it more expensive for companies to raise funds and may deter long-term investors.
- Strategic Shifts: As hedge funds grow and passive funds dominate, the market sees fewer active traders, amplifying the impact of hedge fund activities.
In conclusion, the growing influence of hedge funds in European stock markets is creating a more volatile and unpredictable environment. This trend has significant implications for investors, companies, and the broader financial system. Understanding these dynamics is crucial for making informed investment decisions in today's market landscape.