Last month’s European elections have been described as an earthquake to the established parties across Europe, and serve to highlight the difficulties facing the political establishment in Brussels in how they intend to deal with a crisis that shows no signs of coming to a conclusion any time soon.
Slow growth, falling prices and high unemployment in the euro area are a direct consequence of the fiscal readjustment process being undertaken throughout the euro area.
It would be tempting for the political establishment to put last month’s vote down to a protest vote from electorates fed up with being ignored by their respective political elites, and there does appear to be a temptation to do just that with a lot of federalists like Jean Claude Juncker calling for an increase to the pace of fiscal integration.
This would be a mistake given that the protest came from across the political divide of left and right with strong gains on the left in Greece and Spain and from the right in France.
European leaders have an opportunity to think long and hard about what steps to take next with respect to economic policy in the euro area over the next few years. Get it right and Europe as a whole will feel the benefit, but get it wrong and Europe will struggle to grow at all over the next five to ten years.
The European Central Bank can only do so much to fix the problems around the European economy, given the restrictions surrounding its mandate, which means politicians need to start enacting reforms that are likely to be unpopular in the short term but should bear fruit in the long term.
While stock markets reacted well to the ECB measures this month the reaction of the currency markets was much more telling with the euro initially dropping sharply, before rebounding just as quickly on the basis that these ECB measures aren’t set to start before September.
As monetary policy moves into the realms of the experimental, it is hard to believe that €400bn worth of so called TLTRO’s, will be any more successful that the much bigger €2trn worth of LTRO’s that the ECB tried and failed with over the past two years, particularly with growth remaining so tepid and unemployment still high.
As far as financial markets are concerned that means European leaders need to try to put in place policies to push the euro lower and make it easier for small companies to employ people and grow their businesses.
With last month’s disappointing Q1 GDP numbers still fresh in the memory and equity markets in Europe still looking remarkably strong, despite last week’s pullback it begs the question as to whether the gains seen so far this year suggest that investors are overestimating the economic rebound that we are likely to see in Europe over the course of the next 12 months.
If that is the case then there remains the distinct possibility that the current recovery in equity markets is running on fumes, particularly with the DAX having failed to consolidate its move beyond the psychologically important 10,000 level last week.
Since we broke above the 9,790 level earlier this year the direction of travel has been pretty much one way traffic and this current up move is only likely to gain traction higher if we are able to establish a foothold above the 10,000 level.
While the DAX failed to move beyond the 10,000 level the underperformance of the FTSE 100 continues to confound having failed once again to push beyond the 6,900 level.
Since the beginning of this year the FTSE100 has tested the area between 6,880 and 6,900 six times and failed on each occasion. If it doesn’t break soon that would suggest that we could get a move back towards the lows in April around 6,510.
Investors are likely to remain twitchy for the foreseeable future, particularly in light of last week’s events in Iraq, and the subsequent rise in oil prices. If oil prices continue to remain elevated then that could well act as a drag on economic growth over the course of the next few months, which means that events in Iraq are likely to drive the winds of investor sentiment for some time to come.
What this means for markets this week is anybody's guess, but given that we still remain fairly close to record highs, we're going to need to see a significant reduction in tensions, as well as a significant improvement in the data coming out of the US economy, to feel confident about the next move in equity markets this week.
Whether we believe the current economic fundamentals merit such elevated equity market levels is neither here nor there. As rate levels continue to fall investors are more likely to gravitate towards equities until such times they feel they can better value elsewhere, which makes it important to follow the trends.
For now the trend in the DAX is higher, and until such time as we break below 9,800, the January 2014 highs, the dips look likely to get bought.
Using a straightforward projection measuring technique we can still project a potential move towards 10,160, but we need to stay above 9,800, to maintain the current momentum, having broken below trend line support from the April lows.
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