DAX Rally Looks Fatigued

The sharp rally in the DAX has stalled this week, partly reflecting investor concerns about the health of the European economy, where high inflation and low economic growth continue to pose a great risk to risk assets. The optimism regarding peak inflation in the US has also started to wane, with US indices hesitant to add to last week’s sharp gains when a drop in CPI sent risk assets soaring.

Equally, there are no fresh catalysts to trigger a sell-off, with the missile landing in Poland, which caused markets to drop late in the day yesterday, looking increasingly like an accident. Still, on balance, I feel like the risks are skewed to the downside, with the ECB continuing to prioritize fight against high inflation at a time of low economic growth.

Indeed, all the major indices look a little bit overbought and with inflation remaining elevated in Europe, it is becoming increasingly difficult for investors to justify buying stocks in this environment. Thus, at best, we may see at least some more consolidation and a bit of a pullback.

The DAX future has indeed shown some signs of fatigue around 14400, which was the base of the breakdown in June. The RSI momentum indicator meanwhile has raced to over the “overbought” threshold of 70. So, the hesitation should not surprise anyone.

While the DAX holds above the 200-day average, I can’t be super bearish on the index from a purely technical viewpoint. For now, I am merely eying a modest pullback. But in the event that we go back below the 200-day at some point, and hold below it, that’s when I will turn decidedly bearish again. You have to respect the market, even if you don’t agree with it.

With that in mind, keep a close eye on yesterday’s low at 14142. If that level breaks, the next downside target would be at 13970, followed by the base of last week’s breakout at 13712. As mentioned, the potential for an even larger sell-off is there if the 200-day MA breaks, but we will cross that bridge if and when we get there.

Meanwhile, from a macro point of view, there’s not an awful lot of positive news to encourage the bulls to keep the market's bid at these elevated levels, and without a pullback first.

The ECB’s Vice President has said that the central bank must prioritize fight against high inflation. Luis de Guindos said that the main risk for financial stability and economic growth is very high inflation rate, and the ECB should start with passive quantitative tightening before reducing balance sheet.

If UK inflation data is anything to go by, prices have likely risen further in the Eurozone, where an energy crunch and low economic output is continuing to eat into consumers’ incomes. UK CPI surged to a 41-year high of 11.1% in October, fueled by soaring energy bills.

Ever since Russia slashed supplies of natural gas to Europe, the cost of electricity in wholesale markets across the region has risen sharply and with the war continuing, there’s little hope of a speedy drop in prices.

It is also worth keeping an eye on the situation regarding the missile landing in Poland, with NATO allies still trying to establish the facts. What we so far know is that two people were killed after the missile landed in eastern Poland. It is not clear whether it was, as many people suspect, a stray rocket from Ukrainian or Russian forces. It comes after a wave of Russian strikes on Ukraine yesterday, dashing any hopes of an end to the war.

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Disclaimer: At the time of publication, the author had no positions in the securities mentioned.