The European stock markets have bounced off their lows following another weaker start. At the time of this writing, the major indices are trading flat with the FTSE up only slightly. Mainland European stocks are continuing to take cues from the FX markets and specifically the EUR/USD, which has a strong negative correlation with the likes of the DAX and IBEX. The world’s most heavily-traded FX pair has been surging higher in the recent days mainly because of weakness in US data; correspondingly, European equities have been moving south. Of course, the slowing pace of growth in the world’s largest economy matters for the stock market too because it is one of the main export destinations for most of the major European companies. A weaker euro is obviously good news for European exports. But now that it is rising, stock market speculators are paring back their bullish bets accordingly. In the UK, stocks are held back by continued uncertainty over the general elections, now just a week away. The potential impact of a hung parliament is weighing on investor sentiment here, hence the FTSE’s recent pullback from the record highs. Admittedly, the FTSE’s constituents are multi-national corporations which rely more on global macro factors than the domestic political situation. Nevertheless, some companies and/or sectors will be affected by the outcome of the election – HSBC, for example, has already warned that it is considering moving its HQ elsewhere because of the UK’s position in Europe. In addition to the macro worries, the company earnings from European have not been great. London-listed Shell, RBS, Smith & Nephew and ICG were among the companies who reported their results today. Only results from Shell and Smith & Nephew were better than expected, even if the former’s net profits plunged 56% due to the plunge in crude prices.
The FTSE has found support just ahead of the 6900 level this morning, which has lifted the index back above the 50-day moving average (6940). It is important to remember the significance of 6900. Traders may recall that this had been a major resistance area in the past. Now that it has been broken, this level is a primary reference point for the bullish speculators and is in their interest to defend it. That said however the significance of 6900 has been eroded somewhat after the whipsaw we saw in March. Nevertheless the index has bounced back today and the technical outlook is on the verge of turning back bullish. This depends to some degree on whether the buyers will be able to push the FTSE above the broken support at 6975 and hold there on a closing basis. If successful, the path of least resistance would be to the upside once more and a move towards the Fibonacci extension levels at virgin territories, shown on the chart, would become likely.
However, there is no guarantee that the index will break back above the old support at 6975 and even if it does, the potential follow-up technical buying may not be that strong. After all, we are heading into the month of May now and the oft-quoted “sell in May and go away” would be playing in the back of some investors’ minds. What’s more, the RSI is clearly in a state of bearish divergence with the index, correctly suggesting that the bullish momentum was weakening. The RSI is now testing its bullish trend and if it were to break this then it may precede the underlying FTSE index doing the same. The trend line on the FTSE comes in somewhere around 6845. Significantly, this level also corresponds with the important Fibonacci retracement level of 61.8%.Thus if this level were to be broken then we may well see a much larger correction towards at least the 200-day moving average at 6715.