DAX 40 Nears Inflection Point

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Can The Rally Extend Further?

MARKET INSIGHTS
15 Nov 2022

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Global markets experienced a turbo charged rally last week helped by U.S. CPI data for October, which showed that prices have risen less than expected. The CPI rose by 0.4% MoM and by 7.7% YoY, raising expectations that the Federal Reserve and other central banks will slow the pace of its monetary policy tightening. However, hawkish comments from U.S. Fed officials tempered hopes of a less aggressive pace of interest rate hikes and pointed that investors should pay attention to the “endpoint” of rate hikes which is likely to be “a way off” from current levels. It’s likely that the Fed would wait to see number of declining inflation reports before a pause is considered.

On Tuesday the ZEW indicator of Economic sentiment for Germany rose by 22.5 points to -36.7 in November 2022, well above market expectations of -50.0. This suggests that the economic outlook for Germany has improved since October, most probably on hopes that inflation could peak soon, and the European Central Bank could slow the pace of its monetary tightening policy.

German output is likely to shrink this and next quarter as the high natural gas prices resulting from the Russia-Ukraine war is hurting households and manufacturers. The chemical industry is under pressure, because of its heavy usage of energy and inability to pass the higher costs onto consumers.

The International Monetary Fund (IMF) warned on the weekend that the global economic outlook is even gloomier than projected last month, particularly in Europe, with economic activity in most developed economies set to contract amid broad-based elevated inflation and a steady worsening in purchasing manager surveys, which measure manufacturing and service sector activity.

The IMF blamed the deteriorating outlook on tightening monetary policy triggered by persistently high inflation, weak growth in China, the war in Ukraine, and ongoing supply chain disruptions.

A worsening energy crisis in Europe would severely impact growth and trigger a prolonged high inflation, which could prompt larger than anticipated policy interest rate hikes. The ECB is trying to avoid overtightening and is far behind the Fed and other central banks, as aggressive rate hikes could destroy productive capacity.

EU officials cut their economic growth forecasts for 2023 amid serious energy crisis in Europe, uncertainty due to the war in Ukraine and eroded purchasing power for households. There is risk for potential further shocks especially in the currently unfavourable gas market with potential shortages in in the winter of 2023-2024. The economic growth forecast for 2022 is 3.2%, while for 2023, the European Commission forecasts growth of only 0.3% compared to previous expectations of 1.4% (released in July), with the German economy likely to contract the most in 2023.

In October 2022, inflation in the EU reached a new high of 10.7%, while the average price growth could come around 8.5% in 2022. Inflation is expected to be around 6.1% in 2023 and 2.6% in 2024. Inflation continues to grow faster than expected and the economic outlook deteriorated significantly.

In Europe policy makers are maintaining its stance that for as long as broad-based inflation remains high, interest rate hikes are on the agenda. The ECB is likely to bring its monetary policy rate above 2%, but the previous jumbo rate hikes are unlikely to become a norm.

Source: Tradingview

The German benchmark DAX 40 rose sharply last week in tandem with global peers extending the rally from its September 2021 low, amid European bond yields easing, despite short-dated rates remaining near multi-year highs. Germany’s 2-year government bond yield reached a high of 2.25% last week which is the highest level since December 2008.

As we all know bull or bear markets do not unfold in a straight-line fashion, and the current bear market is no exception. The DAX 40 rebounded in late September 2022 and is currently trading at its highest level in five months. Several key static and dynamic resistance levels have been cleared, showing improvement in momentum. The daily RSI and stochastic indicators have reached strongly overbought territory suggesting that the index is due for a pull back to unwind its overbought momentum conditions. Despite the recent improvement in the price structure and in the momentum conditions, it is unlikely the down trend has reversed course and we are of the view that any further short-term upside from here is likely to be limited.

Active investors looking for magnified exposure to the index could check out our 3x Germany 40 and -3x Germany 40 ETPS to take advantage of upcoming up and down swings in the index.

Your capital is at risk if you invest. You could lose all your investment. Please see the full risk warning here.

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Violeta Todorova

15 Nov 2022