Bad news is good news for the markets that rely on central bank support. And so it proved again this morning, as the latest European data disappointed expectations yet the major stock indices rallied as if everything was just fine. The rationale is that weakness in data will ensure that the likes of the European Central Bank and the Bank of England will maintain their uber-dovish policy stance for longer.
Their actions would keep bond yields depressed, underpinning higher yielding assets like equities. At the same time, the virtually zero interest rates will lead to higher borrowing and spending by households and businesses, keeping the economy in motion.
But to be fair, today’s data wasn’t too bad – not when you consider the fact that the Brexit vote had only just occurred at the end of June. In fact, the Eurozone services PMI actually managed to climb to a three-month high of 53.1 from 52.9 previously, driven by a robust PMI reading in France.
However, that’s where the good news ends. The manufacturing PMIs for France, Germany and the Eurozone as a whole all disappointed expectations, while the German services PMI fell more than 1 point to 53.3.
The economic calendar is going to be light this week, with most of the action taking place on Friday. But we will have the usual weekly US crude stockpiles report on Wednesday and the German Ifo Business Climate, which is an index based a surveyed manufacturers, builders, wholesalers and retailers, to keep us busy on Thursday.
Technical outlook: DAX
Yesterday saw the DAX, the benchmark German stock index, dropped sharply into a key support range amid no news, leading to some premature calls that another crash was forthcoming. While that may still happen, we think that the underlying market structure is bullish and we therefore expect to see higher stock price levels in the coming days.
Indeed, the DAX recently took out the neckline of its inverse Head and Shoulders pattern as it famously broke out of its consolidation pattern on Tuesday 9 August and quickly ‘filled’ the gap that it had left behind at the start of the year.
It appears as though those breakout traders then took advantage of short-term ‘overbought’ conditions (as the momentum indicator RSI traded near 70) and took profit at around the key resistance level of 10745 (which we had highlighted in our prior DAX report here). Meanwhile the rising 50-day moving average has now climbed above the 200 in a development called a “Golden Crossover.”
For some momentum traders, when the moving averages reside in this order, they only look for buy rather than sell setups. Thus, going forward, the DAX could also find support from this group of market participants.
With that price action in mind, on Friday we highlighted the possibility that the DAX could drop into the key support area in the 10335 to 10475 range (the point of origin of its prior breakout and old resistance zone), before bouncing higher (see “DAX: Could stocks rebound soon?” for more). As it has so far turned out, this is exactly what has happened at the start of this week.
While it is still far too early, this bounce could potentially lead to the onset of another big rally. However, if the buyers fail to hold their ground in this 10335-10475 area then this would be a very bearish outcome.
Our base case however is that the bulls will win the battle here and that we could see a potential rebound towards the prior resistance level of 10745, and eventually the long-term 61.8% Fibonacci retracement level at 10980, which is also the projected point D of the ABCD pattern.
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