DAX analysis: Contrasting forces for the German benchmark

13th February 2017

Report by Przemysław Kwiecień PhD CFA

David Cheetham

  • The DAX (DE30) has been in a bullish mode so far in 2017 and the technical picture seems to remain favourable
  • However, political risks in Europe are on the rise and the earnings season in Germany has been disappointing so far
  • Traders could watch the key 11450 support level and the monthly candle; moreover, DE30 could underperform against the US500 in months to come
Intro:

The DAX30 (DE30 on xStation platform) had a phenomenal finish to 2016. While its movement in 2017 was not as notable, the index has still moved higher once more. Right after the US elections, the German benchmark tested a major barrier of 10,000. Now it’s 17% higher. Rather surprisingly, this is an even larger rally than the one seen on the S&P500 (US500 on xStation platform). Whereas the US market benefits from tax cuts expectations and a very solid earnings season, investors in Germany could soon be intimidated by political risks on the horizon. In this analysis, we provide an outlook for the DE30 market and offer our view on the possible dynamic between DE30 and US500 going forward.

Fundamental take:

Over the past couple of months the DE30 has benefited from a combination of factors including the ECB’s QE extension, decent macroeconomic data from Germany and the global post-US election rally. However, as these positive developments have been priced in, some key risks may have been omitted.

The most substantial risk for the months to come is politics. Depending on final decisions in Italy we may have elections in as many as four major EU countries this year, with populistic and anti-EU parties on the rise. While worries were contained in January, a political scandal in France and a shift in polls in Germany has already shaken this calm by the beginning of February. In France, Francois Fillon, a pro-market candidate, has been hit by a “fake-jobs” scandal and dropped from the first to the third place in polls, leaving markets with a dismal prospect of an anti-EU Marine Le Pen or a left-wing candidate Emmanuel Macron, whose economic proposals could be detrimental for growth and public finances. On top of that a gap in polls between the market-favoured CDU-CSU and the SPD has been greatly reduced in Germany, with the latter gaining ground. Obviously, these election worries may not materialise but if 2016 taught investors anything, it is to expect the unexpected. A further rise in political uncertainty may eventually bite into market sentiment.
 

Electoral Calendar in Europe
DAX - desktop UK.png DAX mobile UK-1.png

Political uncertainty is a major risk for equity markets in Europe for 2017.

While US indices (like US500) benefit from a combination of tax cuts expectations and a very solid earnings season, this is not the case for the DE30. 10 out of the 30 companies on the DAX have released results so far, with half missing expectations and only two exceeding forecasts. While the earnings season is in a relatively early stage, these proportions are far worse than in any of the previous eight quarters. Earnings growth below expectations could undermine confidence and encourage correction of relatively high valuations.


Finally, while the US markets surged on expectations of lower corporate taxes, this change could actually be detrimental to European companies on a relative basis. At the moment the effective tax rate is similar in the US and Germany, at just under 30%. In the US this rate could be lowered by around 10pp, which could increase valuations by some 10%. In Germany, Minister Schauble hinted at lower taxes but details were in short supply - not to mention the ongoing uncertainty of the election outcome. From this perspective, outperformance of the DE30 against the US500 seems unjustified.

Technical take:

The DE30 remains in a bullish trend on any interval from H4 to MN1. If we do see a decline then traders could pay close attention to the prior support level at 11450. This was a local high from late 2015 and after being broken above in December 2016, it has since served as a strong support. For as long as this support holds, the trend is bullish and new highs (above 11885) are possible. Only a break below this level could provide bears with a chance to push price significantly lower. Longer-term traders could pay attention to this month’s candle. January’s candle was bullish but had a substantial upper shade, which may be seen an early signal of weakness. As we are approaching all time highs one could compare the present situation to March/April of 2015. Following a bullish candle with an upper shade for March, we had all-time highs in April but eventually the month ended in the red. A powerful bearish engulfing pattern appeared as a consequence and led to a significant correction. Should a similar pattern be repeated it would also create a large double top with highs from 2015 and provide a potentially strong reversal signal
de30at-1.png de30at-2.png

Source: xStation5

A technical picture remains bullish for as long as the key 11450 level holds. Source: xStation5

Conclusions:


Although the technical trend is clearly bullish for now and we could see new highs this month, the fundamental picture seems to be deteriorating as political uncertainty in Europe increases and earnings season could end in a disappointment. Should political uncertainties rise further and lead to a break of the key 11450 support, a correction could well be in the offing. Furthermore, investors should pay attention to the DE30 monthly candle as there are some signs that it could be starting to form a bearish pattern. Finally, a fundamental divergence could favour the US500 compared to the DE30.

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