Madrid's bourse suffered its worst day in two years on Friday, dragging down the broad European equity market, after the Valencia region asked for a bailout, rekindling concerns about Spain's financial health and the euro zone debt crisis. Spanish 10-year sovereign bond yields surged to historic highs, moving further above the 7 percent line that markets view as too expensive to be sustainable.
---- FTSEurofirst down 1.5 percent
In equities, investors rushed to take profits on a rally which has seen the FTSEurofirst 300 gain 10 percent since early June to hit 4-1/2 month highs on Thursday. Few wanted to hold on to bets through the weekend or their summer holidays. Banks and insurers, which stand to lose out on their sovereign bond holdings and loan books if the euro zone crisis intensifies, were among the top fallers after Valencia said it would apply to the government for help.
"There is very little to stop Spanish bond (yields) moving up at the moment, and that is a big concern," said Ed Shing, head of European equity strategy at Barclays. "This is just another piece of bad news reminding people that it is not just the government that has issues but also the regional governments." The FTSEurofirst 300 closed down 1.5 percent at 1,048.98 points, retreating from Thursday's 4-1/2 month high but still managing to eke out a 0.6 percent gain for the week. The pan-European benchmark has now notched up seven weekly gains - its best consecutive run in seven years.
Spain's IBEX fell 5.8 percent to six week lows in its biggest one-day percentage drop since May 2010, according to Reuters data. Italy's FTSEMIB dropped 4.4 percent. The news from Valencia underlined how far Europe still has to go to resolve the crisis, coming on the same day as euro zone finance ministers approved a 100 billion euro rescue plan for Spanish banks.
A cut in the Spanish government's economic growth forecasts that points to recession well into next year added to the gloom. "I am concerned," said Hans Peterson, global head of investment strategy at SEB Private Banking. "I would not advise going directly into a broad exposure on Europe."
Implied volatility on Euro STOXX 50 index, known as VSTOXX and seen as a crude barometer of investor risk aversion, jumped 16 percent in its biggest one-day rise in three months. The expiry of the July options contracts during Friday's session added to volatility in mid-morning trade, with EuroSTOXX 50 battered around the 2,300 level, heavy with both put and call strikes. The index traded below the mark at the 1000 GMT expiry and closed down 2.8 percent at 2,237.33 points.
The thin trading volumes of the summer holiday season exacerbated market moves. Volumes on FTSEurofirst fell for the fifth week in a row, to their lowest weekly level since January. "We've had a pretty good run this week ... People are just taking a bit of risk off the table ahead of the weekend, just in case," said the head of dealing at an asset management firm.
For the longer-term investor who reckons Europe will be able to survive the current crisis, however, the market's weakness presents an opportunity to cash in on attractive valuations - the EuroSTOXX 50 trades on a 12-month forward price-to-earnings ratio of 8.7 times compared to 12.1 times for the US S&P 500, according to Thomson Reuters Datastream.
"Of course ... that will be a long road so the market has to accept that and during this time we will have good news, bad news, good news, bad news, and that's why we have this move today. I don't think it changes the overall prospects," said Vincent Guenzi, chief strategist at Cholet Dupont.
"I want to slowly increase the weight of stocks in the portfolio when there are better opportunities, so today may be a better opportunity than yesterday," he added. He also said the Italian and French markets currently offer a good compromise between battered Spain and popular but relatively expensive Germany.
Peterson at SEB agreed, saying that even in the current climate there were opportunities in Europe for those who pick carefully, including cashing in on a weaker euro that is likely to benefit exporters. The euro, also dented by the Spanish concerns, tumbled broadly on Friday, hitting record lows versus the Australian, Canadian and New Zealand dollars.