DAX turns lower on concerns over end of QE, health of European banks

Stocks took their time but are now sharply lower on the day. This is possibly a delayed response to yesterday’s news that the Fed has ended QE, as after all today's European earnings results and economic data have been decent. There are doubts about the European Central Bank’s ability to support the markets in the same way that the Fed has with their use of unconventional policy tools. On top of this, there are renewed fears about the health of the banking sector. Andrea Enria, chairman of the European Banking Authority, today said that “the story is not over, even for the banks [that passed the stress tests.]” Shares in banks have fallen sharply, most notably in the peripheries. Even the likes of Barclays have turned lower despite reporting better than expected results. In Germany, Commerzbank and Deutsche Bank are lower by around 3% each. This sharp turnaround has overshadowed an otherwise good day of corporate earnings results. Car makers Renault and Volkswagen; energy companies such as Shell and ENI, and German drugmaker Bayer are among the European companies that have reported better than expected results. On the macro front, unemployment in Germany fell by a good 22,000 in September compared to a rise of 4,000 expected and a prior month’s gain of 9,000. Spain’s economy grew in the third quarter by 0.5% as expected. All eyes are now again on the US where we have the third quarter GDP data coming up at 12:30 GMT. It is expected to have grown by a solid annualised rate of 3.1% compared to 4.6% in the previous quarter.

But despite the cheerful German unemployment data and the decent earnings results, the major indices are lower across the board with the UK’s FTSE down 1%, the DAX in Germany off by 1.5% and the Spanish Ibex 2% lower. The big question is whether the second wave of the sell-off that started around the middle of last month has now begun, or is this just a blip? With the Fed’s QE stimulus no longer there, one has to wonder what will support the overvalued stock markets at these lofty levels.

Technical outlook

The technicals point to a mixed outlook for the major indices, but generally they appear very heavy and in danger of collapsing under their own weight. The DAX, for example, has already created a long-term Head and Shoulders (H&S) reversal pattern and so it may have topped out. Admittedly, the bounce back from around the middle of this month has been sharper than I had envisaged which could be a sign of things to come. But I still feel that another ugly correction could be on the way. As the 1-hour chart shows in figure 2, the index has already broken below a short-term bullish trend line, which thus suggests that the recovery trend has ended. The selling could accelerate if the index now breaks back below the neckline of that long-term H&S pattern at 8860. Incidentally, the 38.2% Fibonacci retracement level of the recent rally also comes in just shy of this level, at 8850. Thus this makes this 8850/60 a key support area. There will likely be a lot of stop loss order below this area and if they get triggered then we could see another leg lower with the next support being the 61.8% Fibonacci level at 8660. If the index falls to that level then a revisit of this month’s low around 8350 could also become a possibility. Meanwhile a potential break above the 9140/60 resistance area would be a very bullish outcome.