DAX emitting smoke as German carmakers plunge Chinese concerns revive

The European stock markets have fallen viciously today, led by an almost 3 per cent decline for the German DAX index. At the time of this writing, Volkswagen shares were down another 20 per cent after the firm admitted using software to rig emissions tests. Other German carmakers were also lower on fears the probe will expand to all German diesel cars. In London, mining stocks were leading the way lower after renewed fears about China saw copper and other commodity prices plunge. It looks like the latest concerns were triggered by the Chinese Academy of Social Sciences and the Asian Development Bank. The former said the world’s second largest economy was likely to grow by 6.9% in 2015, while the latter trimmed its forecasts for Chinese growth to ‘just’ 6.8% for this year and 6.7% for next year.

Fears about the full impact of the emission rigging scandal and prospects of slower growth in China makes for a toxic mix for German carmakers. Although VW may have lost a BIG chunk of its value, its shares could plunge even further if it is forced to pay a lot more than the €6.5 billion it has set aside to handle the consequences of rigging US emissions tests or if there are criminal charges for VW executives. And things could turn really ugly if the probe expands to and finds other German carmakers guilty too.

On potential source of support for German stocks could come in the form of a weaker euro, which looks like has ended its strong negative correlation with the stock markets. This is because the safe haven government bonds are finding support as investors liquidate their long equity positions, causing the yields to fall.  If the euro continues to weaken then we may see a slowdown in the sell-off later today and a potential bounce back at some later stage this week.

However all bets would be off if Wednesday’s manufacturing PMI data from China and the Eurozone and/or the German Ifo Business Climate on Thursday badly disappoint expectations.

Technical outlook:  long-term bullish trend in sight

Unsurprisingly, things look pretty grim for the German benchmark stock index from a technical perspective. As can be seen from the chart, the kick-back rally that began towards the end of August ended around 10520. It is interesting to note that this level roughly corresponded with the 38.2% Fibonacci retracement level of the downswing from the record high. As this is a shallow retracement, it suggests that the bears are in full control of things and that this next leg of the sell-off could be quite significant; so far it is proving that way. The index is currently displaying a large bearish engulfing candle on its daily chart and if it closes today’s session around these levels then this candle would point to further weakness for the days to come.

There are much further short-term support levels now in sight, so the next key level could be around 9400-94500 which corresponds with a bullish trend line that has been in place since 2011. If the bulls do not show up there, the August low at 9320 could be the next bearish target, followed by the Fibonacci levels shown on the chart.

For the bulls to take back control, they will first and foremost need to push the index back above the long term pivotal level of 10,000. If and when this is achieved, a potential rally towards 10400 may then get underway.