Given the extremely negative sentiment in the media (fears about Grexit, Ukraine-Russia stand off and terrorist threats et al.) the European stock market rally is fast becoming one of the most hated one. This makes us rather bullish. Admittedly, Europe has underperformed the US massively in recent years and the valuations do look a little stretched, especially in the US, which means a correction of some sort may be on the way for the global stock markets at some point in the future. But that aside and ignoring the risks of Greece actually exiting the Eurozone, the fundamental outlook for European markets look rather bullish in our view. In fact Germany’s DAX index has already hit several record highs this year alone and is holding near those unchartered territories as investors await fresh direction from Greece. With the UK’s FTSE also not too far from its own all-time peak, it could be argued that the underperforming French CAC index may have a lot catching up to do. So, could the CAC be the next major index to join the fun?
It is likely that the ECB’s bond buying programme will help drive government bond yields further lower, pushing investors into riskier stock markets. After all, a similar sort of stimulus programmes by the Federal Reserve helped to fuel a multi-year rally on Wall Street, so there is no reason why this cannot be repeated in Europe. In fact, there’s evidence that suggest investors are already rotating out of US stocks and into Europe. According to Bank of America Merrill Lynch, using data from EPFR for their analysis, European equity funds have recorded their fourth consecutive week of inflows, while in the US, outflows from funds were recorded for the fifth straight week. Clearly, investors are showing preference for quantitative easing over a stronger economy. That said, the latest macroeconomic pointers from the Eurozone have not been bad at all. This morning for example we found out that industrial production in France grew by a surprisingly large 1.5% month-over-month in December while in Italy it rose by 0.4%. Imagine how the markets’ may react if we now see a flurry of some really decent numbers! Meanwhile the on-going economic recovery in the US, if sustained, should help to support European exports, particularly when you consider the added benefit of a weaker euro. Last but not least, the lower oil prices may help to boost consumer spending, not just in Europe but elsewhere too. Thus, there are plenty of reasons why the outlook for the stock markets looks bright. But as mentioned, the situation in Greece does pose a major risk.
Since our last report on the CAC, the French index hasn’t made much headway. But it hasn’t dropped either, despite facing all the negativity in the meantime. In fact, it has managed to consolidate inside a tight range above 4600, which was the high from last year. So, the probability for a sharp move higher is there, particularly if Greece reaches a deal with the troika this week or at some point this month. That said, the CAC will have to clear some key Fibonacci hurdles that are now in sight before it could potentially take off. As can be seen on the chart, these are the 161.8% extension of the most recent downswing from point B to C, at 4740; the 127.2% extension of the downswing from the 2014 high (move from point X to A), at 4820, and the long-term 61.8% retracement of the bear move from 2007 to 2009, at 4755.
However our short-term bullish view on the CAC would be invalidated upon a decisive break below 4600. In that case, the index could tumble towards the next support at 4500 or even lower still at 4425. This would also be psychological blow for the bulls as it would indicate that they lacked conviction to buy at these fresh multi-year highs. Meanwhile the RSI is trending higher after pulling back from the overbought threshold of >70 a couple of days ago. This suggests that the bullish momentum is still there, although a potential move below 60 and a break of the trend line would invalidate this view.