“We see six signs of capitulation flows data,” begins UBS’s weekly European Flow Watch research note sent to clients yesterday.

According to the bank’s analysts, the six signs of capitulation in European equity markets in European equity markets are:

• Banks: Investors have been net sellers of the banks the first time in five and half years. The recent risk-off move has seen the most net selling of any sector over January.
• Country selling: On both a 12-week and 14-week view, Italy saw the largest net outflows since 2014. However, buying of stocks in the Core Eurozone area has spiked and has only been higher once since 2010.
• Hedge fund net leverage at 2009 lows: Hedge fund net leverage is measured by UBS’s prime brokerage teams at 27%, the lowest recorded level since Draghi’s “whatever it takes” speech in summer 2012 and in line with levels previously seen in March 2009.
• US investors have turned net sellers: US investors have become net sellers YTD of European ETF’s. What’s notable about this fact is that the selling is offsetting the structural growth of ETF’s.
• US equity funds have seen the biggest outflow since March 2009: Following on from the above point, US equity funds have seen the largest outflow since March 2009 YTD. In January 2016, US equity funds saw outflows of $27.4 billion versus March 2009 outflows of $31.5 billion.
• Cyclicals vs. Defensives: Cyclicals net selling has head to the highest level since the end of last August, and the outflows/inflows into these two sectors is reaching extreme levels.

Sentiment indicators are also showing an extremely bearish mood among investors. According to UBS’s research, the Stoxx 600 and the Bulls less Bears are both close to 2 standard deviations below their long-run average (shown in the chart below). However, UBS goes on to point out that, in the past, when bullish sentiment has been this low for European equities, over the next 12 months the European equity universe gone on to return c20%. Only time will tell if this will be the case this time around.

Capitulation: Not all flows are created equal

As noted above, UBS’s data shows that equity flows into core European markets have remained robust over the past few months. UBS has mapped the most and least favored countries by investors. For example, the biggest net inflows were seen in France and Germany. The least favored countries were Italy and the UK. The sectors which saw the most buying were Insurance, Leisure, and Real Estate while the least favored sectors were Banks, Commodities and Basic Resources.

CDS on a number of European banks now exceed that of the Emerging Markets. So, if you’re a contrarian and believe that European markets could rise by 20% from their current depressed levels, the sector to target would be Banks, and the country to target would be Italy. Italian banks have been the worst performing sector in the core Eurozone market YTD.

The Italian financial sector is down 16.1% since the end of last year. On the other hand, Italy’s Utility sector is the Europe’s best performing sector YTD up 24.7%. For Europe as a whole, Sweden’s Consumer Discretionary sector has chalked up the worst performance, down 24.8% year-to-date.Net buying

UBS – Net buying

Looking at the underlying data of UBS’s European Equity Flows research report, it seems that in aggregate, UBS’s clients have been net buyers of European equities during January. That said, there has been a clear defensive positioning with net selling of cyclicals relative to defensives.

Moreover, hedge funds have been persistent sellers since the end of last year, and as a result, leverage in the European hedge fund complex has come down sharply. On the other hand, long only investors have been net buyers, having been net sellers the fourth quarter of last year.

ETFs/ETPs listed in Europe gathered a record 82 billion US dollars in net new assets in 2015. Interestingly, UBS’s data shows that when long only investors turn net buyers, as hedge funds turned net sellers and reduce leverage, equities are close to a bottom. In particular, long only investors were large net buyers close to the bottom of the market following the summer selloff in 2011, when the Stoxx 600 fell close to 20% over four weeks. Similarly, during the first quarter of 2009 long only investor flows seemed to flag the bottom of the market amid the financial crisis.

On a sector by sector basis, UBS’s flows data shows that over the past 12 weeks the European Insurance sector saw the highest level of net buying since the data began in 2005. Also, the Leisure sector saw the highest level of net buying in seven years over the same period. Since the beginning of November, the Banks sector has seen the most aggressive outflows in 5 ½ years.