2023 fundamental and technical outlook on major European equity indices.
Is there a risk that the current bear market rally might soon run out of steam?
Following on from the weaker-than-expected US October Consumer Price Inflation (CPI) data in early November, this week’s US Federal Reserve (Fed) minutes showed that a substantial majority of policymakers agreed it would soon be appropriate to slow the pace of interest rate hikes as they assess the impact of their tightening policy on the economy.
The potential slow down in the rate hike cycle boosted not only US equity indices but also their European counterparts amid, for now at least, positive market sentiment.
Since a long weekend, such as the current Thanksgiving break in the US, dries up trading volumes, not just in the US, but also in other locations, it is likely that a high volatility move may be seen early next week, however.
These tend to happen in the opposite direction to the prevailing trend, wrong footing the majority of market participants, which means that the risks of another swift down leg being witnessed in the US but also on this side of the pond, is increasing as time goes by.
Can the European equity bear market rally last until year end and into 2023?
The short answer is yes but we may first see a possibly significant drop in the next couple of weeks before what is known as the traditional “Christmas rally”, helped by US 401k retirement plan inflows into equities towards the end of the year, pushes equity indices in the US and Europe back up again.
Why the current equity rally is probably not the beginning of a new bull market
The Fed’s commitment to reduce US inflation back to its (2%) target, something which in the past has taken on average around five years, highlights the risk of a significant contraction, not just in the US economy but also around Europe, being seen in early 2023 which would most likely have a detrimental effect on earnings and drive down equity prices once more.
Furthermore, stock allocation at the recent equity indices lows in October were relatively high at over 60% and cash allocations relatively low at below 25% when compared to previous bear market lows when the former was closer to the 40% mark and the latter, cash allocation, shot up to as high as 40% in investment portfolios, the exception being the rapid Covid crash with an around 55% stock allocation.
The data suggest that we haven’t seen any capitulation yet, neither in the US, nor in European equity markets. Since some kind of capitulation or extremely negative market sentiment usually accompanies bear market bottoms, it is likely that the October-to-November rally in equities is exactly that, a strong bear market rally in a long-term bear market and not the beginning of a new bull market.
With the majority of major economies around the world either being close to or technically already in a recession, another rout in stock market performance is thus likely to ensue during 2023, especially if earnings begin to disappoint.
Having said that, this doesn’t exclude another approximately 5% rally in European stock indices (from current levels as of 25 November) taking place by the end of the first quarter of 2023, before the bulk of the 2022 to 2023 bear market possibly rears its head.
Technical view on the DAX 40, CAC 40 and Euro Stoxx 50
The DAX 40 continues its steep October-to-November ascent of so far over 23% and is on track to see its eight’s consecutive weekly bullish close despite surging Covid-19 cases to a new record high and related lockdowns in China hurting local sentiment and global recession fears dampening demand.
The index is approaching its April high at 14,599 which may act as short-term resistance. If not, the June peak at 14,712 and the March high at 14,927 should be eyed next but are likely to cap into year end.
While the key 14,814 to 15,059 May 2021 to January 2022 lows aren’t overcome, the risk of another sharp decline being witnessed, remains on the agenda.
Slips may find short-term support at the 14,442 mid-November high amid an increasingly overbought index which next week may give back some of its recent gains as US players return from their extended Thanksgiving weekend.
While the DAX 40 remains above the 200-day simple moving average (SMA) and the 10 November low at 13,572 to 13,545 into year-end, however, the odds of seeing a positive start to 2023 remain high before a possible deterioration in market sentiment amid a gloomier economic outlook kicks off another possibly sharp down leg in Q1 2023.
The French CAC 40 index continues its eight week advance of nearly 20% from its October trough, albeit at a slower pace than in October, as global recession fears remain on investors’ minds and European Central Bank (ECB) policymakers agreed in their October meeting accounts to stick to monetary tightening, even if this were to lead to a shallow recession.
For now, the CAC 40 remains on track to reach its 6,759 late April high. The March high at 6,831, together with the August 2021 high, offer a solid resistance area which may well cap the CAC 40’s advance in the weeks to come.
Support can be spotted at the 6,626 August peak and only a fall through the mid-November low at 6,522 could spell the beginning of the end of the current bear market rally with a retest of the 200-day simple moving average (SMA) at 6,303 remaining a distinct possibility for the first quarter of 2023.
Euro Stoxx 50 front month futures contract
For the Euro Stoxx 50 the technical picture is quite similar to that of the DAX 40 and the CAC 40 in that a short-term retracement lower in late November or early December is likely to be followed by another attempt to the upside towards the end of the year, or the beginning of 2023, taking place before another strong decline may ensue in Q1 2023 on a worsening economic outlook.
Key resistance to watch out for is the 61.8% Fibonacci retracement of the entire 2021-to-2022 bear market which lies close to the minor psychological 4,000 mark. Slightly further up sit the April 2021 to March 2022 highs at 4,026 to 4,049 which may cap in the near future.
While the August 2021 high at 4,251 isn’t exceeded, the risk of another down leg being seen in Q1 2023 remains on the cards. In such a scenario the 200-day simple moving average (SMA) at 3,627 may well be revisited next year.