In the equities section of our 2015 market outlook guide, we put out a rather bullish outlook on the DAX index, suggesting that it could outperform even the US indices at the start of this year. A weaker euro and the likely introduction of QE from the ECB was the main reason for our bullish forecasts. The ECB did of course introduce QE at its January 22 meeting which was somewhat earlier than the market had expected. As per our forecasts, this encouraged investors to pile into German equities, causing the DAX to surge by around 800 points since that ECB meeting. Although we are still bullish on European stocks in general, the pace of the recent rally means that the risks of a correction have increased. So, we encourage traders to exercise extra caution in the coming days and weeks, especially as the Greek saga is at the forefront and European earnings season about to kick into a higher gear. That said, today’s European PMI data have been encouraging while in an unexpected move to boost lending into the real economy, the People’s Bank of China cut lenders’ reserve requirement ratio by 50 basis points to 19.5%. Given the improving macro trends in the Eurozone and central banks’ on-going “race to the bottom” for interest and exchange rates, the long-term trend for stocks remain bullish in our view. Thus even if European equities do come under pressure soon, the potential pullback from these extremes could be shallower compared to the more recent corrections.
Below we have attached two charts of the DAX index, both suggesting that the exhausted DAX could potentially enter a period of consolidation. As the weekly chart shows, the DAX is trading near the resistance trend of its bullish channel and has already reached the 161.8% Fibonacci extension level of the 2007-2009 crash at 10985. This level was the second of our bullish targets for this year. The third target is somewhat higher at just below 11100, which corresponds with the 161.8% extension of the most recent correction between June and October 2014. As a result of the rally, the RSI is now approaching overbought levels (>70) on the week chart. Meanwhile on the daily time frame, the RSI has created a small bearish divergence i.e. the DAX made a higher high while the RSI made a lower high. This suggests that the bullish momentum may be fading. Short term speculators should therefore watch the 10850 support level carefully as a closing break below here could pave the way for some losses. The next key support level is at 10550 and if that breaks down too then we may see a sharp move lower.
But it is important to remember that the DAX alone will not determine the direction for the European stock markets, as after all it comprises of only 30 German-listed companies. In fact, some of the other European indices are currently displaying extremely bullish-looking technical patterns, not least the UK’s FTSE which is potentially on the verge of a major breakout above the 6900 level. Therefore, if the other European markets rally then the DAX could also benefit and extend its gains.