May 31, 2012, 12.41 PM | Source: Reuters
US stock investors have been so concerned about Europe recently that on some days, the mere closing of the region's big stock markets has been enough to spur buying.
The Standard & Poor's 500 Index is down 6% so far in May. Much of the drop can be tied to the euro zone's worsening outlook.
The worry has escalated to the point where US stocks have put together a number of relief rallies in May after 11:30 a.m. EDT (1530 GMT), when European stock markets close. The relief might just be linked to the possibility of bad news diminishing with those markets closed.
Some investors are capitalizing on the tendency for markets to sharply cut losses after Europe signs off for the evening.
"I go long before the close and then get light afterwards and sell into the bump," said Michael Matousek, senior trader at US Global Investors Inc in San Antonio. "It's uncanny the way this trade has been working."
On May 8, the S&P 500 dropped as much as 1.6% in the morning on fears that Greece would reject an existing international bailout and potentially leave the euro zone. But following the European close, equities dramatically cut their losses, and the S&P 500 ended off a mere 0.4%.
On May 9, a loss of as much as 1.5% was cut in half by midday, and the benchmark S&P 500 ended the session with a relatively milder decline of 0.7%.
The trend has even been enough to completely eradicate a day's decline. Renewed worries about Greece's fiscal troubles hit stocks a week ago on May 23, pushing the S&P 500 down by as much as 1.5%. It reversed midday and the S&P 500 ended with a slim gain of 0.2%. The next day, a loss of 0.6% at the S&P 500's session low was turned into a gain of 0.1% for the day.
The odds of Greece leaving the euro zone, and the destabilization it could cause, is the biggest worry. That's compounded by economic headwinds in much of the European Union, particularly in Spain and Italy, two of Europe's largest economies.
Spain's credit level was cut three times in the past month by Egan-Jones Ratings because of its banking system. There are fears that if Greece somehow exits the euro zone, other countries will head for the door, too.
With markets so driven by headlines, the end of the European session is taken as a sign that the day's news flow is winding down - freeing traders to focus on the United States, where the outlook is more optimistic.
BEST HOUSE IN A BAD "'NABE"
Michael Mullaney, chief investment officer of Fiduciary Trust Co in Boston, said US stocks were "the best house in a bad neighborhood, so it doesn't surprise me that money sold from European stocks is being redeployed here."
That's not to say US equities are doing well of late. Stocks have been battered by economic worries, and the drumbeat of negativity out of Europe has been soothed by promises of more money and hopes for stimulus, little of which has helped Europe.
In the last month, just one S&P 500 sector, telecom stocks, has posted gains. Telecom stocks are among the least exposed to Europe, while the worst performers - materials, financials and technology - have much larger exposures to Europe.
"The trend higher is a flight to safety, with money allocated towards us because our equities seem like a safe haven in comparison," said Douglas DePietro, head of trading at Evercore Partners in New York, who added that some of the gains were coming on money flows from overseas.
SHORT-TERM TRADERS' PLAYTIME
On days when the market rebounds, the gains are broad but pronounced in cyclical sectors tied to economic growth.
US Global's Matousek said he plays this trade with gold mining stocks, "which revert to the mean after Europe closes. When the pop happens, I lean into it."
Even options traders are getting in on the action.
Ryan Detrick, senior technical strategist at Schaeffer's Investment Research in Cincinnati, detailed a strategy of "aggressive buying" of calls for the SPDR S&P 500 ETF .
"Basically, you would start buying right around 11:15 or so, and hold them only for 60 to 90 minutes," he said.
Once Europe closes and US stocks move higher, the premium, or cost, for those calls would increase, and the buyer could sell them for a profit.
The start and close of each market session have historically been the two most volatile periods of each day, with volume spiking as participants set or close out positions, actions that can exacerbate market moves.
The 11:30 a.m. close of European markets does not see a similar spike in volume. Matousek said he is waiting to see if activity increases at that time, a sign the trade is becoming crowded. According to Credit Suisse, the close of European markets hasn't met with a corresponding spike in volume among investors expecting a short-term pop in shares.
"The second more people start playing it, it'll be over," Matousek said. "But for the moment, this is a gold mine."