Key Takeaways:
Bank of America has warned that European stocks could be heading for a crash after a key momentum indicator fell deep into a "danger zone" that has historically preceded sharp market reversals.
"The deepening price momentum crash signal is driven by all three of the indicator's inputs: implied volatility, momentum volatility, and trend reversal risk," Paulina Strzelinska, a BofA quant strategist, said in a note.
The bank's European Momentum Conviction Indicator dropped to 17, well below the critical threshold of 30. A reading at this level typically points to a high risk of a 12-month price momentum crash over the next four to eight weeks. The warning follows a fifth straight week of outflows from Europe-focused equity funds, which saw investors pull more than $1.5 billion, according to the bank's analysis.
The sustained withdrawals reflect growing investor aversion to the region, even as the STOXX Europe 600 trades at a historical discount to US markets. The dynamic suggests a significant reassessment of the region's equity risk premium is underway, with one strategist highlighting a growing divergence between buoyant equity markets and recent jitters in the bond market.
The bearish signal from Bank of America comes as investors grow increasingly cautious on European equities. The five consecutive weeks of withdrawals show a clear trend of capital flight, undermining valuations despite the STOXX Europe 600 trading at a relatively low 13.5 times forward earnings.
This sentiment was echoed by Neil Birrell, chief investment officer at Premier Miton Investor, who told CNBC it is "only a matter of time" before recent bond market instability spills over into stocks.
According to Strzelinska, the slide in the momentum indicator points "primarily to volatility-driven regime-shift risk." Momentum is a critical factor used by quantitative funds to model investment strategies. The plunge in BofA's gauge suggests that these systematic funds could begin to unwind their positions, adding further selling pressure to the market. While the signal points to some evidence of trend acceleration, the bank's note stopped short of calling it a "full-blown momentum bubble."
This article is for informational purposes only and does not constitute investment advice.
