DAX: stocks drop as PMIs disappoint

European stocks are sharply lower this morning as investors react to fresh signs of a slowdown in the global economic recovery. In recent weeks, data from the world’s largest economies – the US and China, in particular – have generally been disappointing. This trend continued for China overnight as the HSBC Flash Manufacturing PMI for April slipped to a 12-month low of 49.7 from 50.3 previously, missing expectations by one whole point. The bad news did not end there as all of the latest European PMIs were also disappointing: the Eurozone manufacturing PMI fell to 51.9 from 52.2 previously while the services PMI edged lower to 53.7 from 54.2. On top of all this, retail sales in the UK unexpectedly fell 0.5% month-over-month in March when a rise of 0.4% was expected.

The European stock markets did however manage to stage a short-lived mini rally off their lows in mid-morning. In part this was due to technical reasons as the DAX, for example, found some buying interest around its 50-day moving average. In addition, investors are still optimistic that Greece will strike a deal with the Eurogroup on Friday which, if seen, would remove one big source of uncertainty over the markets. Hence, they are being hesitant at increasing their bearish bets boldly at this stage. What’s more, the disappointment in terms of the euro zone data simply dashes talks about the ECB possibly reducing QE before its intended end date. It is the sort of reaction we were accustomed to during the US Federal Reserve’s asset purchases programme: bad data = good news for stocks. Will we see a similar pattern if the euro zone data continues to disappoint expectations?

As mentioned, the German DAX index found some short-lived support this morning when it tested its 50-day moving average. However it has now lost some of that momentum and is close to its lows once again. Given the abovementioned risks (Greece, global economic slowdown concerns, etc.) and the extent of the rally from October to April, when the index nearly increased 50% in value, the probability of a correction is now quite high, in our view. Indeed, there are a few technical warning signs that suggest a vicious sell-off may be on the cards soon: a broken trend line and the bearish divergence between the RSI (lower high) and the index (higher high).

Going forward, the key support level to watch is at 11625/35, which was the low from March and also last week. If this level gives way at the third time of asking then we may see the start of a move towards the medium-term bullish trend line in the coming days. The exact location of the trend line depends on the speed of the potential sell-off. It is also worth watching the 23.6% Fibonacci retracement level at 11445/50 as this may also provide some support, should we get there. Meanwhile if the buyers manage to hold their nerves here and cause the DAX to rally then the key level they would need to break down is around 12040. Beyond this level, 12220 could be the next major hurdle and then there is nothing significant until 12400 – the high from earlier in the month.

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