Authored by Bloomnerg’s Michael Msika
Markets like a good pattern. The current set-up is no exception, and is looking increasingly like 2015: a good first half, a Chinese slowdown, PMIs not picking up, late-cycle signs with central banks set to ease to boost growth. There are a few differences of course, and one of them is the trade war. This could go either way, and while there’s no panic yet, investors should be cautious as we test the market’s resilience.
August hasn’t been a great month for European shares since the start of the decade. In 2011 and 2015 the month was particularly tough, with the Stoxx 600 falling 11% and 8.5% respectively. The index is down 2% so far this month.
“A market correction on trade-war escalation is always one tweet away,” says Oddo-BHF strategist Sylvain Goyon, arguing that investors got a wake-up call after the recent complacency. With earnings growth and macro indicators heading south, the equity risk premium cannot deflate and it would not be surprising to see the Stoxx 600 falling back towards the 370 level, Goyon says.
Looking at charts, the technical set-up is starting to look ugly. The European gauge is testing its upward technical trend started last December, after breaking its 50- and 100-day moving averages last week. The last time the index broke below its uptrend channel, back in April, we got a month-long 7% downside move. Granted, the uptrend back then was significantly steeper than now.
Last month, the Euro Stoxx 50 index failed to break above the 3,540 points resistance after some disappointment from central bank policies. The index is now facing the danger of continued profit taking, according to DZ Bank analyst Dirk Oppermann.
That said, there is no sign of panic just yet. The implied volatility of the Euro Stoxx 50 rose last week, but didn’t surpass the highs seen last May. Continuous volatility selling flow from structured-product desks may be capping the move, and proper panic-selling might be needed before we see higher volatility levels.
Looking at market breadth, the signals aren’t too alarming either. The amount of members triggering a momentum sell signal is not elevated and same goes for stocks trading above their 200-day moving average.
The very short-term view offers some positives as the downtrend initiated after July’s ECB meeting has now reached the lower end again, particularly on the exporters-rich DAX index. Technical indicators like the Relative Strength Index (RSI) also show an oversold signal, which could trigger a bounce in markets at some point.
With China letting the yuan tumble to the weakest level in more than a decade on Monday and asking state-owned companies to suspend imports of U.S. agricultural products, the ball is now back in President Trump’s camp.
In the meantime, Euro Stoxx 50 is down 1.7% while S&P 500 futures are down 1.3%.