Forced sellers cast shadow over equity markets

By Sitaraman Shankar and Simon Challis

LONDON (Reuters) - Investors looking for the next shoe to drop in Europe's stock bear market are watching the region's pension funds and insurers uneasily.

The reasons for their discomfort: the prospect of forced selling by European insurers, which prompted the last stock market collapse in 2003; and fears pension funds could worsen the situation by extending their move out of equities.

But while these threats loom over an edgy market, analysts say prices would have to fall by up to 15 to 20 percent more before the two groups dump stock, and the effect of any selling will be less pronounced than in the past.

European markets are extremely vulnerable: shares have fallen 30 percent from a 6-1/2 year peak hit a year ago, driven by a credit market crisis, an economic slowdown, and big losses at the region's top banks.

Among those hit have been UK blue-chip company pension funds, which slipped into the red in June, hurt by falling shares and higher inflation expectations.

"It is a further risk out there -- if you see material falls from these levels, it could drag potential forced sellers into the market and exacerbate the situation, causing stock prices to overshoot fundamentals," said Royal Bank of Scotland strategist Ian Richards.

"If the market were to trade 10 percent lower than where we are now, a lot more attention will be paid and a lot more questions will be asked about when the forced sellers are brought into this process."

Insurance companies could be forced into selling stocks because they hold a lot of equities as capital and as prices fall they need reduce stock holdings to protect the solvency margin set by industry regulators.