DAX tanks as euro surges ahead of big earnings

Mainland European stock indices, led by the German DAX, have been hit hard this week. From its high on Thursday, the DAX has fallen some 375 points. Since hitting a record high in June, it has dropped more than 750 points, losing 5.8 per cent in the process. In contrast, the UK’s FTSE was off only 150 points or 2% from its all-time high at the time of this writing. Meanwhile in the US, the major indices were hovering slightly below the record highs hit, in some cases, earlier this week.

So, what is going on with the DAX?

The short answer is the euro. The single currency continued its upsurge yesterday even as the European Central Bank tried to appear as dovish as it possibly could in the current circumstances. Mario Draghi, the ECB President, diverted the attention away from the appreciating currency at his press conference. The market interpreted this as a sign that Draghi and his ECB colleagues are not too concerned about the impact of the euro on Eurozone exports. Companies that make up the DAX have about half of their sales come from exports. The recent appreciation of the euro makes German exports less competitive as they become relatively more expensive for overseas buyers. Also weighing on the DAX is profit-taking ahead of major earnings next week. Among the stocks that make up the DAX index, Deutsche Boerse and Daimler are reporting their results on Wednesday, while on Thursday we will have results from BASF, Bayer AG, Deutsche Bank and Volkswagen.

Are European investors overreacting?

The euro’s impact on exports and earnings are the obvious worry. But are European investors overreacting a little? After all, the ECB doesn’t appear to be in a hurry to start the process of normalising its monetary policy. Even when QE is tapered, interest rates will remain at these historic low levels for a while yet. The prospects of stronger demand from within the Eurozone should support German exports. What’s more, recent Chinese data suggests the world’s second largest economy may have avoided a hard landing. If so, we should expect to see increased levels of Chinese demand for high end luxury goods. In the short-term, the upcoming earnings releases from German companies could turn out to be stronger than expected. So, although it looks bleak now, the DAX could look very different in the coming weeks.

Technical outlook not quite bearish just yet

Technically, the index’s failure to hold above the old all-time high of 12390 is bearish. But the last significant low at 11940 area has not broken down yet. So we don’t have a lower low in place to suggest the bullish trend is over. We are now watching the possibility of the DAX ‘filling’ its gap at 12160 before possibly pushing higher again. It will also be a bullish outcome if the broken support area between 12320 and 12405 is reclaimed by the bulls. So, as things stand, the bullish trend has indeed weakened but not ended. Any short-term bullish setups could see the buyers pick the dips again now that the RSI has unwound from overbought levels.