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European stocks seeing outsized moves - data, investors

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Hedge funds, changed market structure seen as behind trend

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Share moves have less to do with company fundamentals -

sources

By Nell Mackenzie, Dhara Ranasinghe and Samuel Indyk

July 15 (Reuters) - European companies are seeing

outsized gains and losses in their shares when they report

earnings, a Reuters analysis shows, a trend that has more to do

with the growing sway of fast money in the $15 trillion market

than with business prospects.

Take the top 60 companies in Europe's broad STOXX 600 Index

: when they reported earnings over the past year, their

average daily stock moves were 18% higher than eight years ago,

the analysis of more than 120,000 days of share price data from

LSEG shows.

The swings on earnings days over the past 12 months were the

largest since at least 2016, when compared to average daily

moves, the survey shows.

The reasons for this rise in volatility are hard to pin down

precisely but stem in large part from the growing dominance of

hedge funds that chase trends in search of quick profit,

according to interviews with two dozen traders and investors as

well as a review of broker research for hedge funds and other

sophisticated investors.

"You have mostly short-term money driving the market," said

Krishna Kumar, CIO at Goose Hollow, a macro hedge fund. "So,

participants who are not interested in the stock for the next

five years but are looking at it for the next five days."

A dozen of the experts interviewed by Reuters - including

equity trading chiefs at three Wall Street firms that say they

control about a third of the market - singled out multi-strategy

hedge funds, which are among the largest and pursue diverse

investment approaches under the same roof, as one of the drivers

of the phenomenon.

The influence of hedge funds has been amplified by changes

in market structure and the makeup of investors that have

thinned the range of participants and trading volumes, according

to the interviews and brokerage reports.

Long-term asset managers have poured cash into cheaper funds

that simply track indices. And many buy-and-hold investors have

left the scene as European economic growth has languished, with

Lipper data showing more than half a trillion dollars of

outflows from the market since 2016.

Reuters analysed share price volatility back to 2016 in

order to capture data since the Brexit referendum that year. New

regulations since Brexit have splintered trading across a larger

number of markets, some of them private and non-transparent,

diminishing volumes and making it easier to influence publicly

quoted prices.

"Now you have these situations where stuff can just come get

you out of the blue, like oddball post-earnings moves," said

Steve Sosnick, chief strategist at multi-national brokerage firm

Interactive Brokers ( IBKR ), which processes on average 2.4 million

trades per day globally. "That's a tough environment for

stocks."

As regulations push more financial activity away from the

regulated banking sector, the influence of hedge funds is

growing across a broad range of financial markets. Reuters

reported in March how they were piling into  the euro zone's $10

trillion government bond market.

Asked to comment on Reuters findings, a hedge fund industry

representative said the sector plays an essential role in the

smooth functioning of markets.

Jack Inglis, chief executive of the trade group Alternative

Investment Management Association, said hedge funds make an

"integral contribution to deep, diverse, and accessible capital

markets and the financing of the EU economy."

"They do this by providing liquidity, conducting their own

research, improving corporate governance, and undertaking

investments which other investors may be reluctant to hold,"

Inglis said.

MARKET INEFFICIENCIES

While large stock price swings are not necessarily a threat

to the functioning of the market, they risk triggering broader

problems and can make it more expensive for companies to raise

money, experts said.

Stocks that are integral to financial stability may be swept

up in these moves. The March 2023 banking crisis highlighted how

a sudden slide in bank shares can wreak havoc by shaking

confidence in the institution.

"These one-day post earning price moves are significant,

point to market inefficiencies and higher investor risk," said

Mark Williams, who teaches finance at Boston University's

Questrom School of Business.

Williams was one of six market experts, including four

academics, who reviewed the data and Reuters' analysis,

validating the findings.

He warned that increased volatility could drive away

longer-term investors, over time.

Two executives of listed financial firms in the UK, who

requested anonymity to speak candidly about the matter, said in

separate interviews that they saw increased short-term activity

by hedge funds deflecting the focus away from their companies'

longer-term strategic outlook.

Both said they had seen more hedge funds focused on

shorter-term returns attend their presentation days.

ESMA, the European securities watchdog, did not address

Reuters' findings directly. But the regulator acknowledged

liquidity, a measure of the volume of trading, has dropped.

ESMA said it "remains concerned about persistent nervousness

and the potentially limited market resilience in the presence of

ongoing uncertainty."

Since 2020, the average number of daily stock trades has

dropped 7% on public stock exchanges as activity moved to other

venues, such as bilateral trading on bank platforms and

so-called 'dark pools', according to data from BMLL

Technologies, a technology platform that collects trading

exchange data going back to 2017.

MEANINGFUL RISE

Reuters calculated the percentage change between the highs

and lows in the first trading session after earnings were

released across the 60 companies with the largest weights in the

STOXX 600 index. Earnings days were used because they are

clearly identifiable news events and comparable between

companies.

The Reuters analysis showed that the swings in the last

12-months in the share prices of these companies averaged 5.13%,

up from 4.34% in 2016, with a gradual and consistent rise

showing a trend.

The exception was between 2021 and 2022, during COVID-19

lockdowns and when Russia's invasion of Ukraine upended markets

and led to larger moves.

Steven Novakovic, managing director of the CAIA curriculum,

a professional qualification for people who work in alternative

investments, said Reuters findings "show a meaningful rise in

intra-day swings, not only over an eight-year period, but also

relative to the last few years."

Some of the biggest moves seen in the past year included

shares of Swiss lender UBS and automaker Ferrari ( RACE )

, which saw daily moves over 10% and 12%, respectively.

UBS and Ferrari ( RACE ) declined to comment.

Reuters could not determine the cause behind every move, but

the volatility of UBS shares after it reported earnings on May 7

illustrates how hedge funds can influence the market.

The Swiss lender's first-quarter results trounced forecasts,

sending its shares 5.7% higher at open.

But some hedge funds were short on the stock, wagering that

the share price would decline, according to a note from a

broking firm that buys and sells securities for hedge funds. The

note, which was shown to Reuters on the condition that the

brokerage not be named, has not been previously reported.

Faced with losing bets, these funds were forced to buy UBS

stock to close their positions, further fueling the market

gains, the broker note said. There was little buying by traders

other than hedge funds, it noted.

UBS stock surged over 10% that day.

Interactive Brokers' ( IBKR ) Sosnick also said he witnessed a short

squeeze of hedge funds on May 7, saying options bets around UBS

stock were indicative of their positions.

SHORT-TERM MONEY

Changes to Europe's stock market structure have increased

the impact of hedge fund trades over the past few years,

according to the interviews and brokerage research.

Goldman Sachs ( GS ) estimated in a November 2023 client note, seen

by Reuters, that of the $4 trillion in stocks it tracks in

Europe, 41% are held by passive funds, which typically follow an

index. The proportion has roughly doubled since 2010, the bank's

data showed, meaning there are fewer active traders in the

market.

Hedge funds, meanwhile, are growing. Their net exposure to

the region's stocks has risen, approaching highs last seen in

2010, according to a July prime brokerage note from Morgan

Stanley ( MS ).

In addition, funds are juicing their bets with debt, giving

them even more financial firepower. The amount of money they

borrow from banks returned to record highs in May before easing

a touch in June, two Goldman notes seen by Reuters showed.

Among hedge funds, multi-strategy funds are growing even

faster. Globally, the top five multi-manager funds have grown to

oversee $368 billion, more than double the $149 billion they ran

in 2018, according to a Goldman report from September, which

does not identify the funds.

The STOXX 600 market cap has grown roughly 20% in the same

timeframe.

These big traders turn over their stock portfolios between

two and four times a year, and sometimes more, making them

active traders in stocks, said two brokers at banks that lend to

hedge funds.

Multi-strategy funds include Millennium Partners, Point72,

Citadel and Balyasny. The funds declined to provide comments on

the findings.

(Additional reporting by Danilo Masoni, Amanda Cooper, Carolyn

Cohn, Tommy Reggiori Wilkes, Sinead Cruise and Lucy Raitano;

Editing by Elisa Martinuzzi, Paritosh Bansal and Daniel Flynn)