Do European stocks follow the lead of the US market from the previous day? In other words if, say, the US market is down one day are European stocks more likely to fall in their trading session the following day?
To test this the following chart plots the daily returns of the S&P 500 Index against the corresponding daily return of the EuroSTOXX 50 Index for the following day.
There is a positive correlation here, but as can be easily seen it is a very weak correlation. And this observation is supported by the very low R2 of 0.05.
So the immediate answer to the question of whether European stocks follow the US is: only very slightly.
However, the following chart is interesting. This next chart plots the daily returns for the two indices as above, but this time it is the daily returns for the same day. In other words, this time the US market movements come after those in Europe.
As can be seen, here the correlation is higher than in the above first case. The R2 = 0.3; which while not statistically very significant is quite a bit higher than in the first case.
So, this might suggest that it is the US market that follows Europe.
Is this the case?
Probably not. Rather it is likely to be a feature of the trading hours of the respective markets. The illustration below shows the trading hours for five exchanges.
NB. Strictly, UK and Swiss stocks are not in the EuroSTOXX 50 Index but the exchanges are included here for reference.
The times referenced here are UTC – which are accurate at the time of writing (in May), but will be shifted one hour when countries switch to Daylight Savings Time. However, for the purposes of the discussion here the times are fine, because what we are interested in is the overlap of trading hours at the end of trading in Europe and the beginning of trading in New York each day.
As can be seen, each day there is an overlap of a couple of hours between the Paris and New York exchanges, and longer for Frankfurt and New York. Each day European markets can be active at their open in the morning (reacting to overnight developments – including US stock movements), then often these markets can tread water for a while waiting for the US market to open in the afternoon. The European markets can then take their lead from the US for the rest of their trading day.
The higher correlation seen in the second chart above is therefore probably reflecting this overlap period when European stocks are influenced by what is happening in the US that same day.