DAX continues ascendency as traders cheer QE… but are they underestimating Grexit risks?

On Thursday, the European stock markets came to life after a hesitant start as investors had to wait until the start of the ECB press conference before pushing the “buy” button. And that they did as soon as Mario Draghi announced QE. Although question marks were immediately raised about the risk-sharing aspect of bond buying, the fact that these purchases will be a huge 60 billion euros per month until – and potentially beyond – September 2016, rather than merely the end of this year, has clearly cheered investors. The reaction of the market makes sense as QE is designed to make the already-low rates even less appealing, causing yield-seeking investors to move funds into other, riskier, assets such as equities. Indeed, government bond yields have extended their falls and are trading at or close to record lows in Germany, France, Spain and Italy. In theory, this should be good news for stocks, especially export-oriented ones, which make Germany’s DAX index particularly attractive. It is hardly surprising therefore that a stock like BMW is trading at a fresh all-time high.

While it can be argued that the bullish enthusiasm should continue for the foreseeable future, the market’s focus is likely to shift to the Greek elections on Sunday. Although “Grexit” worries have been put to the back burner, they could come back to the forefront as early as Monday if the Greeks choose to elect the anti-austerity Syriza party into power. Thus, it can be argued that investors may be underestimating the risks of Greece eventually exiting the euro zone. That said, the leader of Syriza has changed tack recently; instead of forcing his country to exit the Eurozone, he has instead promised to negotiate the terms of the bailout if he wins. Although the German’s have been vocal in their opposition for negotiation, the feeling in the market is that they may have to come to a compromise should Syriza win because the Eurozone is still better off with rather than without Greece. On top of this, it is widely believed that a vast majority of the European companies that were previously heavily exposed to Greece, have now reduced their exposure and are therefore better papered for its potential exit. Nevertheless, European banks such as France’s BNP Paribas, Credit Agricole and SocGen may still have some direct and indirect exposure to the troubled nation. This could potentially halt the European stock market rally.

It is therefore important to watch the key technical levels closely. As the DAX is trading at a record high, there are no price reference points to guide us. As a result, we have to rely on projected levels from past price action. This is where the Fibonacci extension levels come handy. I may have gone a bit OTT with this tool as you can see, but as a trader, I know how important Fibonacci levels are. To make things easy, I have labelled the most recent price swings from which the extension levels are derived from. As can be seen, it is uncanny how the index has paused at the recent extension levels such as those around 10335 and 10510, before continuing in its upward trajectory. Three more extension levels are now in sight, around 10640/45, 10840/5 and then 11100, which admittedly are a bit spaced out. The first of these target marks the convergence of two extension levels of price swings from C to D (161.8%) and G to H (261.8%). Above here and ahead of the next Fibonacci target is the resistance trend of the bullish channel, the location of which depends on the speed at which the index gets there, if it does. Meanwhile, old resistance levels are likely to turn into support. As such, it is important to watch 10510 and 10335 very closely. With Greece set to dominate headlines soon, there is potential that these support levels could be revisited a lot sooner than it looks at the moment. That said, both the technical and fundamental pictures are clearly very bullish, even if the RSI is suggesting that the DAX may be at an overbought level.