The new week has started with a bang for the global stock markets. Sentiment has been boosted by hopes that the US tax reform bill is clearing the final stages of Congress. The bill would cut the corporate tax rate to 21% from 35% and boost the take-home pay of many Americans. Clearly, this is good news for companies and it explains why the markets are rallying in anticipation. This however also means that investors may have already priced in the fiscal stimulus from this policy. Thus, if and when the bill makes it into law then we may not see any further immediate gains from this source alone. That being said, between now and the end of the year, there isn’t a lot on the agenda that may cause a sudden shift in sentiment. So, even if the markets do pullback amid profit-taking on the expected announcement of the bill making it into the law, the dip could be short-lived. Many market participants may very well be anticipating a Santa rally into the year-end anyway, and will thus hold off expressing their bearish views in a meaningful way until the start of next year, or after the fourth quarter earnings results are out of the way. So, sentiment could remain positive for a while yet.
But one thing is for sure: equity prices are getting very expensive, and at some point a nasty correction will happen and wipe out billions of dollar worth of valuation from the stock markets, especially on Wall Street. In contrast, European investors have been buying stocks at a more sober rate than in the US. Here, not all major stock indices have hit record highs, and those that have, there hadn’t been significant follow-through to the upside. This means that the potential is there for Europe to play catch up going forward. Indeed, the ECB will maintain its bond buying programme until the end of the year, which means monetary policy will remain extremely accommodative in the Eurozone which should continue to provide support for equities and government bond prices. Thus, it wouldn’t come as surprise to us if in 2018 the European markets start to outperform their US counterparts as investors take advantage of potentially more valuable stocks in this side of the pond.
But any potential weakness on Wall Street in the short-term could unravel the rally even in Europe. The DAX’s big rally at the start of this week has left a big gap between 13103 and 13206, which may eventually get filled. Could it be this week, next week or months from now, no one knows. But not all gaps get filled. Indeed, some of the gaps from September are wider than the distance between Man City and everyone else in the Premier League. Yet like Man City, the DAX has powered ahead, and looks set to end the year at the top of the table with maximum points in Europe. But like football teams, the markets can unravel very quickly. With that in mind, a daily close below the gap at 13103 would be rather bearish, in which case we could see a sizeable pullback. Short-term support comes in around 13220-13240 area now. Resistance is seen at 13345, a level which was formerly support. If broken, the bulls may then aim for 13441 then the record high at 13525, followed by the Fibonacci extensions levels shown on the chart.