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The DAX is Dancing on a Trend-Line of Disaster

The DAX is Dancing on a Trend-Line of Disaster

2015-10-07 17:11:00
James Stanley, Strategist
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Talking Points:

  • German stocks continue to trade higher after briefly-breaching a long-running trend-line last week.
  • The DAX has continued to trade higher despite the fact that we’ve seen two consecutive days of disappointing, contractionary prints for German industry; which has been a strong point of the economy while the index was setting all-time highs.
  • The DAX is very aligned with general risk trends, with the potential for offering an accelerated movement given the 48.5% ramp that was seen in the index from October 2014-April 2015.

Do you remember the taper tantrum? It seems like so long ago, but in reality we’re just about one year removed the fright that enveloped global financial markets as the largest Central Bank in the world was winding down their most recent QE-outlay. The predominant thought was that, at some point, the Fed was going to hike rates. After all, winding down QE, or making policy ‘less loose’ seemed like a logical prelude to hiking rates (tightening policy).

Investors around-the-world sounded the alarm bells as risk assets sold off in droves. Global stocks got hammered as the prospect of tighter policy from the United States was enough to dishevel risk-trends that had been building higher-and-higher over the previous five years of QE-fueled policy direction; and the realization that, at some point, the punch bowl was going to be pulled was too stark for investors to ignore.

The DAX (GER30) was no different, as we saw the index shed -15.5% from September 19th to October 16th of 2014. But as these lows came in, something familiar happened: FOMC members began talking about loose policy for longer. They made the assertion that an end of QE didn’t necessarily spell impending higher rates, and they noted that the Federal Reserve could keep policy ‘especially accommodative’ for longer. This passive, dovish tone from the Fed helped to arrest the outsized-declines being seen around-the-world, and stocks ratcheted higher in a very similar manner as to what they’ve been doing over the previous five years.

But this time, the DAX went ballistic: The index shot up by over 48.5% over the next six months; and this is while the entire continent of Europe was grappling with yet another Greek-default scare. A recently-launched European QE-program contributed to these inclines; as the prospect of a more-unified Europe led by the consistent and formulaic growth of a German economy could, one day, prosper should the global economy ‘turn the corner.’

But no corners have been turned, and policy in the United States isn’t going to stay ‘especially accommodative’ forever. As these realizations have provided a head-butt to global financial markets, the DAX has given back most of that post-October 2014 gain as that previously ‘bubbling’ up-trend has turned into a pain-chain of a down-trend.

The lows marked by the threats of tighter policy out of the US (which, in-turn, would likely impact equities around-the-world) have provided a clean trend-line on the DAX, and this can be found by connecting the lows of September-October of 2011 to the low of October 16th (shown on the below chart in purple).

The DAX is Dancing on a Trend-Line of Disaster

Created with Marketscope/Trading Station II; prepared by James Stanley

As you can see in the above chart, the past year has brought on two very different trends into German equities; as a breakneck up-trend was quickly began to fade out of the market after setting a new all-time high at 12,398. This top provided a 48.5% movement higher in less than 6 months from the lows set on October 16th of last year. And since then, we’ve seen another trend develop, this time in the opposite direction, that’s seen -19.4% of the indexes value evaporate in the past six months.

We’ve been running into this trend-line over the past six weeks, and the longer we go the more grim the situation looks for DAX bulls. On August 24th, in the midst of the massive sell-off during China’s ‘Black Monday,’ the DAX revisited this trend-line yet again; and provided a vigorous bounce that brought German equities back above 10,500. But that jubilation did not last long, as sellers re-entered the fray and offered stocks lower; but this time buyers were more tepid, as we set a new 2015 low as we inched lower on the charts.

The DAX spent the last week of September and the first portion of October dancing on this support trend-line. On the chart below, we’ve zoomed-in so that we can more granularly investigate near-term price action; and as you can see – we even had a quick breach of this trend-line last week, after an abysmal NFP report created risk-aversion around the world as investors were, once again, ducking for cover.

The DAX is Dancing on a Trend-Line of Disaster

Created with Marketscope/Trading Station II; prepared by James Stanley

Where does the DAX go from here?

Since most risk assets are trading with some degree of correlation right now, one could rest assured that the DAX will likely move along with, at least in the near-term, with overall risk-trends. Should global Central Bankers be able to provide the confidence and assurance that markets have become accustomed to over the past six years, we could see the DAX move on to even more new all-time-highs within the next two years. This would spell a 24%+ incline from current levels, which given the 48.5% run in the DAX from the ‘panic lows’ of the taper tantrum, seems like it could be a modest estimate.

However, should the near-term weakness that’s been seen in the DAX continue to develop into even more economic pain, and should Central Bankers, led by the Fed, fail to provide support to global risk trends, the DAX may have more pain in its future. The October 2014 low could provide a very adequate near-term target at 8,351, and that’s ~16% off of current levels.

--- Written by James Stanley, Analyst for DailyFX.com

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