Key points why we think European stocks may perform better going forward:
European company earnings about to kick into a higher gear – there may be more positive surprises than expected
Economic data continuing to improve in the euro area
Lack of major bearish catalysts is good news for investor sentiment
ECB may announce taper plan, but this is priced in; potential for dovish surprise
Technical outlook remains bullish for DAX and other EU indices
The level of investor bullishness we have witnessed on the financial market and recently in Japan has not been experienced in Europe. Yet. After a small pullback yesterday, the Dow looks set to open at a new record high again after earnings from Caterpillar came in much stronger-than-expected. In Europe, investors have proceeded more cautiously, which is reflected in the major indices here climbing a lot less robustly than in the United States. But that could be about to change.
There are a number of fundamental and technical reasons why European indices such as Germany’s DAX could sharply extend their gains. For one thing, the European Central Bank’s likely QE taper announcement on Thursday may be priced in. If anything, the ECB may actually come across as more dovish than expected if it decides to reduce QE but simultaneously extend the duration of the programme. The last thing it would want to do now is preventing the economic growth from accelerating. Indeed, judging by this morning’s release of mostly stronger PMI readings, and other macro data recently, economic activity in the single currency bloc is continuing to improve, thanks above all to favorable monetary conditions. The improvement levels of consumer confidence in the eurozone is good news for stocks and company earnings. The third quarter European earnings season is about to go up a gear or two this week – see the snapshot below. If we see mostly stronger-than-expected earnings results – like we already have on Wall Street – then the likes of the DAX, CAC and euro STOXX could surge higher in the coming days.
Now unlike its peers, the DAX has already broken to a new record high this month before the rally stalled. So, if we are to see anything significant going forward then having made its move first, the German index is the one to watch for continued outperformance amongst its European peers.
Technically, the index’s recent consolidation above the old all-time high can be considered bullish as there was no immediate rejection. Now that there has been accepted at these levels and with the DAX forming a base, this has allowed it to unwind from severally overbought levels mainly through time, which is bullish. Thus unless key support at 12900 breaks first, the path of least resistance remains to the upside. As the index is trading near unchartered territories, one of our favorite ways to look for bullish objectives would be by using the Fibonacci extension tool. As per the chart, the main bullish objective remains at 13245 area, which corresponds to the 127.2% extension of the previous downswing. There are additional Fibonacci extension levels below this level derived from the most recent shorter-term downward move, at 13145 and 13208. But as mentioned, we will be quick to drop our short-term bullish view in the event the DAX breaks back below 12900. Some of the shorter-term support levels that we would also like to see hold include last week’s closing price at 12991 and the previous all-time high at 12951.