European stocks fall by most in 2 months on Syria strike threat

Last Updated: Tue, Aug 27, 2013 16:50 hrs

* FTSEurofirst 300 down 1.7 pct, Euro STOXX 50 down 2.6 pct

* Indexes post biggest drop since June, fall to 1-mth low

* Syria strike threat fuels profit taking on summer rally

By Francesco Canepa

LONDON, Aug 27 (Reuters) - European stocks suffered their biggest daily drop in two months on Tuesday as the threat of a military strike against Syria prompted investors to take profit on some of this summer's best performers and to buy insurance against future losses.

U.S. allies were drafting plans for air strikes and other military action against Syria, causing investors to ditch stocks in favour of assets less exposed to global economic conditions, such as German and U.S. government bonds .

The euro zone's blue-chip Euro STOXX 50 index closed down 2.6 percent, its biggest daily drop since June, leaving it at 2,749.27 points, its lowest level in a month.

Volume on the Euro STOXX 50 was the highest since Aug. 16 as 66.7 million shares were traded, 15 percent more than the index's 90-day average.

The cost of buying options to protect against future market swings, as measured by the Euro STOXX 50 volatility index or VSTOXX, jumped 23.8 percent, the most since February, to a 1-1/2 month high of 22.17 points.

"The Syria story is adding a lot of pressure and is acting as a catalyst," Vincent Cassot, head of equity derivatives strategy at Societe Generale in Paris, said.

"If there is some real escalation in the Middle East (the VSTOXX) can hit 30 very easily."

He said the prospect of an imminent reduction to the Federal Reserve's asset-purchase programme was the underlying driver of market volatility, which he expected to rise further in the run-up to the U.S. central bank's policy meeting on Sept. 17-18.

The Fed's stimulus, along with other bond-buying schemes by global central banks, has helped lead a 34 percent rally in the Euro STOXX 50 since June 2012. The index has pulled back 3.6 percent since mid-August as investors positioned for a cutback in the Fed's programme.

The pan-European FTSEurofirst 300 index of top European shares ended down 1.7 percent at 1,202.36 points, trimming its gains since the start of July to 4.4 percent.

Automotive and banking stocks were the worst hit, skidding around 3.7 percent and 3.1 percent, respectively.

The sectors have led the European equity rally this summer as improving data prompted investors to switch into companies focused on the European economy.

Europe's earnings momentum, however, remains negative at minus 3 percent. That is an indication that despite a recent batch of better-than-expected company results, analysts continue to downgrade their profit forecasts.

Falling profit forecasts at a time of rising share prices have left the broader STOXX Europe 600 trading at 12.9 times its expected earnings, above a 10-year average price-to-earnings ratio of 12.1, according to Thomson Reuters Datastream.

"The full scope of (the Syria) crisis is difficult to predict at this point, so it becomes an excuse for investors to cash in some of the recent gains," said David Thebault, head of quantitative sales trading, at Global Equities in Paris.

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