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5th March - The relative vulnerability of European stocks

05 March 2018

TECHNICALS:

MONTHLY CHART

The lack of ambition in the market has been evident in the way the market has failed to get back above the Prior High in 2015.

DAILY March 2018 Eurostoxx CHART

The rally since the sell-off of late January has been muted: it failed at the first important resistance from the Prior Low at 3455 (never closing above the 50% retracement resistance)

The fresh sell-off looks likely to threaten the Pivot from the low in August of last year.

If the market were to break beneath the pivot at 3390 a top would have clearly formed encouraging still more selling.

FUNDAMENTALS:

 

Prior to the February sell-off US equity markets had enjoyed a strong rally setting several new all-time highs.

But the story in EUROSTOXX had been quite different.

The market made a high late October, early November, and then sold off, contrary to the price action in the US S&P. It then recovered and revisited the highs in January, before the February sell off, but never enjoyed the same strong bull run as its US counterpart, which was surprising given the strength of Euro zone fundamentals.

In the Euro zone, data has for many months been indicating and confirming a strong recovery is finally under way. The various Euro zone PMI surveys have been strong, GDP reports have confirmed that strength and the ECB has been considering how and when to further reduce its QE Bond buying program.

The two factors that are causing it to delay are 1) the relative strength of the Euro, especially against the Dollar, and 2) still low inflation; the ECB has a target of 2.0%, the current level is around 1.3%.

So given these strong fundamentals why the underperformance of the EUROSTOXX market?

Clearly sentiment has a part to play. That sentiment has emanated from the US as traders re-assessed the likely changes to US monetary policy. moreover that assessment had been made more difficult by the change of Chairman at the US Federal Reserve. No one really knew what the new man’s policy stance would be, that was until Tuesday this week when he delivered his first testimony as Chairman at the Senate

But there are other dynamics playing out in the Euro zone:

The German election took place in the Autumn of 2017, but the new coalition government has only just been agreed and even now there are tensions as Merkel gave away powerful ministries to the SPD as the price to be paid for them to agree to a grand coalition.
An election is due soon in Italy and there are candidates standing that are seen as a threat not just to Italy’s continued membership of the Euro, but the EU itself.

Although it is assumed that those outcomes are unlikely, just look at the result of the referendum on the UK’s continued membership of the EU. And the unlikely election victory of Donald Trump in the US. One can no longer simply dismiss these populist politicians as having little chance of gaining power.

These domestic factors are the underlying reason for this markets underperformance together with negative sentiment from the US.

So, now, with fresh bearishness from the US fuelled by

1.Fed Chairman Powell’s testimony on Tuesday which has led to traders increasing the number of US rate hikes they expect the Fed to deliver this year. 
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2.the newly arisen talk of a trade war with the US over steel and aluminium tariffs is an additional negative.

We expect European stock to be hit relatively harder that the US.

 

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Next story:
12th March - Have US Bonds broken down?

Previous story:
17th February - The particular threat to the UK Bond market

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