Euro Stoxx Chart Looks Corrective, Short Term Resistance in Play

European stock markets have recovered nicely along with the debt markets on the periphery following the 'OMT' announcement by the ECB. As we have also pointed out previously, money supply growth in the euro area has begun to accelerate lately, which ceteris paribus tends to support stock prices.

Of course the fact remains that Europe isn't exactly doing very well economically at the moment, but at any given point in time one can never be certain when and whether there will be a slight recovery in economic activity or whether things will get still worse. There have been a few mixed signals recently, for instance Germany's IFO confidence index has  unexpectedly ticked up. This could be a meaningless blip in an ongoing downtrend, but it is worth keeping in mind nonetheless.

 


 

A slight bounce in the German IFO business climate indexes. This was unexpected, but whether it is meaningful remains to be seen – click for better resolution.

 


 

A similar bounce was recorded in euro area-wide confidence data, the first such improvement in a year, but it contained some worrisome details, like e.g. growing expectations of declining business investment in 2013.

Looking at a three year weekly chart of the Euro-Stoxx 50 Index, we can see that its recent behavior looks corrective, i.e., it is very likely an advance that merely corrects the primary downtrend. This implies that the primary trend will eventually resume.

However, this corrective advance could still continue further in the short term – there is a chance that the wave designated 'C' below is only the first wave of a bigger rally. An even longer term monthly chart shows more clearly though why it seems likely that the recent back and forth of the index is only corrective in nature. A rise above 2600 would create more short term upside potential, but the really decisive level in the longer term is approximately at 3050.

 


 

Euro-Stoxx 50 Index: the advance from the 2011 low looks corrective so far. An alternative (in red) is that the advance from early June is only a first wave, and not 'C'. the reason for this qualification is simply that the recent consolidation from the September high does per se not look bearish – click for better resolution.

 


 

A monthly chart of the Euro-Stoxx 50 index doesn't inspire much confidence. It would have to rise above the 3050 level in order to shake off its 'corrective bounce in a bear market' look – click for better resolution.

 


 

Bank Stocks and CDS Spreads on Senior Bank Debt

Below is a chart of the Euro Stoxx Bank Index, as well as our proprietary index of CDS on the senior debt of large European banks. The bank stocks index is currently consolidating below lateral resistance. A break above it would lend more strength to European markets and target the next resistance level – the same holds true conversely for lateral support in the bank CDS index.

 


 

A weekly chart of the Euro-Stoxx bank index: if it can overcome resistance at the 120 level, European stocks will likely have further to rise in the short term. Then the resistance at just above the 150 level would come into play – click for better resolution.

 



 


A long term chart of a slightly adapted version of our proprietary unweighted index of 5 year CDS on the senior debt of major European banks – Santander has replaced BBVA and Monte dei Paschi has been removed. The new composition is: (Santander, Societe Generale, BNP Paribas, Deutsche Bank, UBS, Intesa Sanpaolo and Unicredito) – click for better resolution.

 


 


This index is currently consolidating above lateral support, a mirror image of the Euro-Stoxx bank index. Take note of the divergence between this CDS index and the stock index near the 2011 and 2012 extremes.



Bank Bonds Become Popular


The fact that CDS spreads on the senior debt of European banks are in retreat as well jibes with the fact that investors have lately snapped up the debt of European banks in their incessant search for yield. This is probably not a very bright idea medium to longer term, but it seems to be working so far.

 

“European bank debt, once an investment pariah, is suddenly popular.

In recent weeks, money managers have been readily buying the new bonds of the region’s financial institutions, deals that just months ago would have seemed unpalatable. Bank of Ireland, which received a bailout in 2010, sold $1.3 billion of bonds on Tuesday and found strong demand. It was the largest offering by an Irish bank without a government guarantee in almost three years.

The gradual thawing of the capital markets is a good sign for the region’s banks. In the midst of the crisis, institutions, especially in troubled economies like Ireland and Portugal, have been struggling to raise money from private investors. The latest deals will help bolster banks’ capital levels and strengthen their balance sheets.

But the bonds could leave investors exposed, especially given the precarious situation in Europe. The sovereign debt crisis continues to weigh on the economy. The financial markets remain volatile. And profit at the region’s banks is flagging. “It’s a great time to be issuing high-yield debt but not to be investing in it,” said Robin Doumar, managing partner at the private equity firm Park Square Capital.

For now, bondholders are taking comfort in the policy makers’ response to the sovereign debt crisis.”

 

(emphasis added)

We will see how this sudden appetite for bank bonds works out in the long run, but if it is  sustained in the short term it could render support to bank stocks as well. If so, then the upward correction in European stock markets is likely not yet over.

One reason why one shouldn't get carried away here is however the reason for the sudden enthusiasm mentioned above: “comfort in policy makers' response to the sovereign debt crisis”. What's so comforting about it? As far as we can tell, all that has changed is that there is now a possibility that the ECB might intervene more heavily in certain bond markets. However, it has tried a similar tack before with the SMP, the main difference of which to the OMT program is the seniority question (not an unimportant detail, to be sure).

We recommend watching the 120 level on the bank stock index closely, as well as the 2,600 level on the Euro-Stoxx 50 Index. A break above these levels would argue for a more extensive correction of the downtrend, toward the 150 and 3000 levels respectively.  Conversely, if the indexes fail to break through these resistance levels, then the primary bear market should resume resume very soon.

These observations obviously have implications for the US stock market as well. Although US stocks have outperformed their European counterparts markedly, they are also close to major resistance levels at the moment. The outcome of the challenges to resistance in European markets discussed above is therefore important in a larger context as well.

 


Charts by: bigcharts, Bloomberg, IFO Institute


 

 

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