European stocks recover from lows but sentiment still fragile

European stock indices recovered from losses of between 1% and 2% on Tuesday to trade higher led by bargain hunting in the key European banks that have been hard hit recently, but longer term sentiment remained fragile over the sovereign debt situation and high bond yields for Italy.

The small bounce on the open for European stock markets, on the back of talks for China to buy large amounts of Italian bonds and take stakes in Italian firms, was short lived, with investors continuing to take their lead from bond markets, where the benchmark Italian 10-year bond yields continue to race higher.

When the rumours first started flooding the markets last night of the meeting between the Italian finance ministry and China Investment Corp (CIC), China’s sovereign wealth fund, US stocks were lifted around 2% from their lows in response to the news and there has been a follow through into Asia trading also, which did give European stocks support upon market opening.

However, the bounce was short-lived and investors have quickly come to the conclusion that should CIC strike a deal to buy Italian bonds and stakes in companies there, it will not be the long term solution that the markets want to see.

However, as the afternoon session begun, investors started to trade with more of an opportunistic edge and attempted to pick up some of the badly beaten banking stocks that had been aggressively sold off of late on optimism that they could be due a short bounce. It was this bargain hunting that helped to lead European stock Indices from their lows into the close. The FTSE 100 rose 44 points to 5174, whilst the DAX rose 1.8% on the day and the French CAC, which has badly suffered as its banks were hit by selling waves yesterday, posted gains of 1.4%.

There was initial scepticism towards the talks between the CIC and Italy, which was later rumoured to have not been about buying Italian bonds, but rather taking stakes or investments in Italy’s Industrial sector. This caused Italian 10yr bond yields to rise further on the day to trade at a yield of 5.712%, which will likely keep stock markets and investors fairly jittery.

A longer term Italian bond auction this morning reminded investors at just how much confidence in Italy’s ability to meet its debt obligation sin the long term has deteriorated. 5yr Italian bonds were sold at an average yield of 5.6%, which is the highest yield for 5yr bonds since the inception of the euro.

From a technical perspective the FTSE 100 recovered from support at the 5070 level, which breeds some near term confidence but in truth until the UK Index can break above strong resistance at the 5450 level, rallies will likely remain choppy and fragile.