Look Ahead: Equities
The stock market rotation is in full swing by the looks of it. In the immediate aftermath of Friday’s strong U.S. jobs report, U.S. index futures dropped sharply as the data increased speculation that the Fed may increase interest rates earlier than was previously priced in. In contrast, European markets remained elevated and some indices hit fresh multi-year or all-time highs. The market’s reaction suggests that investors are showing preference for stocks in the euro zone where the central bank is turning dovish. That however is not to say that the U.S. stock market has topped; rather, that it may underperform Europe going forward.
The European Central Bank provided details of its €60 billion a month of monetary stimulus program this week, announcing that it would start on Monday, March 9 and will continue until at least September 2016. This quashed some market speculation that the central bank may delay the program or reduce its duration following the release of some decent Eurozone data. As a result, European shares rallied sharply.
While the euro zone is about to embark on a large scale quantitative easing program, the timing of the Fed’s first rate hike is a hotly debated topic in the US. The strong US jobs report is just likely to increase calls for an earlier rate hike. Indeed, even the Fed’s John Williams has said that “by mid-year it will be the time to have a serious discussion about starting to raise rates”. He has pointed out that the lags in the transmission mechanism of monetary policy argue for raising rates sooner rather than later. However when the Fed does eventually start the rate hiking cycle, it will most likely be gradual at best. So the U.S. stock market rally may have further momentum left in it.
But we would still prefer the European over U.S. stocks, for they have potentially a lot of catching up to do. That said, some of these indices, such as the Euro Stoxx 50, look extremely overbought now and a small pullback should not come as a surprise early next week. As can be seen on the chart, the RSI is at the overbought threshold of 70.
Meanwhile, the index itself is testing some key Fibonacci extension levels around 3633/46 (which are derived from the previous price swings AB and CD). However just because the RSI is at 70 it doesn’t necessarily mean a pullback is imminent. The RSI being at this level actually shows the bullish trend is extremely strong. So, if the index goes on to clear the aforementioned Fibonacci resistance area then there is not much resistance seen until the next Fibonacci target at 3835 (200% of AB). Further targets are at 3870 (261.8% of CD) and 3970, with the latter being the 78.6% retracement level of the bear trend from the 2007 peak. Meanwhile the old resistance levels such as 3605 and 35030 could now turn into support.