DAX finally breaks out of consolidation

August 9, 2016

European stocks have started Tuesday’s session on the front foot after a lacklustre performance on Monday. Sentiment remains upbeat for global equities mainly because of the actions of central banks, rebounding oil prices and the mostly better-than-expected US corporate earnings results.

According to Factset, of the 86% of the S&P 500 companies that have so far reported their earnings results, some 69% have beaten the mean bottom line estimate and 54% have exceeded the mean revenue estimate. As a result, the likes of the Dow and S&P 500 have been able to hit repeated fresh all-time highs over the past few weeks.

In Europe, however, stocks have been far less buoyant as the major indices remain well below their prior record levels or multi-year highs. This has been due, among other things, to the economic stagnation in the Eurozone, troubles with Italian banks, concerns about Brexit, a rapid rise in terrorist threats and so on. But the markets here have started to rise a little more rapidly in recent days, especially the UK’s FTSE 100 following the Bank of England’s decision to trim interest rates to 0.25 per cent and restart QE. Thus, European markets could start to shine more brightly in the coming days and weeks.

Indeed, thanks to the actions of global central banks like the BoE and the ECB, investors are basically deprived of yields and the equity markets provide the only viable alternative for many. The 10-year government bond provides a record low 0.6% yield in the UK and below 1% in Spain now, while those in Germany, Switzerland and Japan provide negative yields. It is these extremely low and negative interest rates across the developed economies that are helping to drive investors into the equity markets which still provide decent yields at acceptable levels of risk.

One to watch: DAX

The German DAX index could be the one to watch now, for it appears to be finally coming out of its consolidation range. As can be seen, the index has broken above prior resistance at 10475 after spending several months below this level. It has also taken out its downward-sloping bearish trend line and appears to have consolidated its position above the 200-day moving average after several false breakouts.

The DAX now needs to hold above 10475 on a daily closing basis in order to confirm the breakout. Unless it turns out to be a false break out, the path of least resistance is now clearly to the upside. As such, we are expecting to see higher levels in the coming days. The first key potential resistance or bullish target could be at 10745, a level below which a gap was formed previously (the gap is still unfilled). Thereafter, the next bullish target could be the 61.8% Fibonacci retracement level against the all-time high, at 10980. Meanwhile the broken resistance level of 10475 could be the new support level to watch going forward. But if this fails to offer good support then there is a risk that the DAX could drop back into its old ranges, leading to a short-term sell-off at the very least.

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