Idea of the Day time for European equities to bounce

What: European equity indices have been under pressure since peaking in May/June. The Eurostoxx 600 index and the Dax have lost approx. 6% each since then and are testing some key support milestones including the 200-day sma. We believe that European stocks may bounce from here. Firstly, we see continued capital inflows into the Eurozone on the back of strong, broad-based economic growth, we also see the pace of euro gains slowing down, and we believe that the ECB will take a cautious approach to ending its Asset Purchase Programme (APP), which is also supportive of equity gains.

There are also signs in other markets that risk sentiment remains well supported, which should be good news for equities. We have looked at the FX market to gauge risk sentiment in the world’s largest market, specifically we have looked at FX returns vs. the USD. Since the start of June Palladium, the Madagascan Ariary, Aussie dollar, Serbian dinar and Swedish Krona have been the best-performing currencies vs. the USD. The euro, pound and the yen are well down the list suggesting that higher yielding and emerging market or commodity currencies are in vogue right now, which highlights a healthy attitude to risk sentiment.

How: As we mentioned, European stocks have been under pressure and are now at a crossroads after reaching their 200-day smas, a key support zone. In the Eurostoxx 600 index, the 200-day sma comes in at 373.50, which is just ahead of the 38.2% retracement of the Nov low to May high at 369.99. We believe that this support zone should be respected, and if we bounce here then we may see back to 382.30 – the 50-day sma and then 380 – the highs from June. A break below 369.00 would be a bearish development that would negate our view and may lead to a further drop back to the 50% retracement level at 361.70. We believe that a further drop in European indices would need to be triggered by an extremal event, either a break down in risk sentiment more broadly or a hawkish Draghi at the week’s upcoming Jackson Hole conference.

Chart 1:

Source: City Index and Bloomberg

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