DAX leads stock market recovery

Last week was a bad one for European stocks as the major indices retreated sharply from their record or multi-year highs. A combination of factors had weighed on the sentiment. These included the nagging Greek concerns and worries about the health of the world’s largest economies – the US and China – following the release of some disappointing economic data. Today however investors have put the disappointments behind them: the leading indices are higher across the board with gains of about 0.5 to 1.7 per cent, led by the German DAX index. Sentiment has been boosted in part by the latest easing step from the People’s Bank of China: at the weekend the central bank reduced the main reserve-requirement ratio (RRR) by 1 percentage point to 18.5% for large banks, and lower for rural lenders. This was the biggest reduction in RRR since the global financial crisis and was undoubtedly in response to weakening domestic economic data after GDP growth slowed to 7% in the first quarter, which was the slowest pace since 2009.

While the aggressive cut in RRR suggests that the PBOC is probably worried about an even sharper slowdown in growth, it is important to remember that the central bank still has a lot of room for manoeuvre – unlike its western counterparts – should things turn really messy. As such, it could be that the markets may have overreacted to the Chinese concerns. Meanwhile this week’s raft of euro zone data could provide some clear direction to the markets ahead of Friday’s Eurogroup meeting (which would be very important as far as the Greek situation is concerned). The German ZEW will be tomorrow’s key data release, followed by the flash manufacturing PMIs and Ifo on Thursday.

It will be interesting to see if the European indices can stage a recovery from these levels after last week’s pullback as key supports are being tested. Take the DAX for example: the German index is currently holding its own above its 50-day moving average (11650) after breaking a short-term bullish trend line as we had pointed out the possibility last week. At the time of this writing, the index is testing the first of the two broken support levels that are highlighted on the daily chart at 11870. Should the index close above here then it may stage a more profound recovery later in the week. But if it sells off from here again then it may also break the 50-day SMA support at the second time of asking before potentially dropping towards the medium-term trend line which comes in somewhere above the 11,000 area. Meanwhile the 1-hour chart of the DAX, in figure 2, shows some more potential resistance levels to watch going forward. These include 11925 (38.2% Fibonacci retracement), 12020 (support-turned-resistance and 50% retracement) and 12110 (61.8% Fibonacci retracement).