European shares' rally pauses for breath

Fri Jan 11, 2013 5:54pm GMT

* FTSEurofirst 300 down 0.1 pct, retreats from 2-yr high

* EuroSTOXX 50 approaches overbought levels

* Strategists turn more cautious, BofAML recommends puts

By Toni Vorobyova

LONDON, Jan 11 (Reuters) - European equities stalled on Friday, 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 U.S. 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 percent 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 U.S. 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 5-day average put/call ratio on the euro zone 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 on Friday, off 1.7 percent, 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 percent 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 percent 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".

"In a market environment in which equities do not rise more than 15 percent, you should own low volatility equities. We still think that apart from a strategic allocation to conservative equities, as we call them, these are still attractive from a technical point of view."