Stock market bulls bruised but not buried yet

European stock markets have had a terrible day, and it could be an ugly finish on Wall Street too where the major indices are sharply lower as we go to press. So much was at stake at this particular ECB meeting, but Mario Draghi and his colleagues clearly disappointed as they chose to cut the deposit rate by only 10 basis points and extended QE by six months. Hopes for a 10-20 billion euro increase in the monthly asset purchases programme were also dashed. Investors panicked and sold their stocks, leading to a very ugly finish in Europe with the DAX closing some 3.6% worse off. The euro was still climbing at the time of this writing and this bodes ill for European exporters.

But once the dust settles down, investors may realise that the long-term outlook for stocks is still favourable because interest rates are at zero across the major economies. And judging by the latest soft patch in US data, the Fed may also surprise in a couple of weeks’ time with a smaller-than-expected rate increase there. The US central bank better raise rates if it wants to maintain any credibility. But it should be noted that despite a hawkish Fed, the major US indices are not too far off their all-time highs, while the European markets are some way off even if the ECB is still pretty much dovish. In a way, the ECB wasn’t going to use up all the tools at its disposal, knowing the Fed’s likely tightening of policy was going to help keep a lid on the EUR/USD exchange rate. Thus, should economic conditions deteriorate the ECB has a lot of room for manoeuvre. So, it may have actually been a clever move by the ECB, even if the market didn’t see it that way. So, know who knows, we could see a sharp rebound in the European markets sooner than how it looks like at the moment.

On Tuesday we sent out a research note on the Euro Stoxx 50, highlighting the potential gains or losses that could have resulted depending on the outcome of the ECB meeting (see “European stocks in wait-and-see mode ahead of ECB” for more). As it has turned out, the ECB was obviously less dovish than expected and the markets have been quick to show their disappointment. The Euro Stoxx has dropped and filled the entire area below key support at 3485 over the past two days. It is currently inside the next key support area between 3285 and 3325. As well as previous support and resistance, the 50-day moving average also comes into play here. Therefore if this key support area also breaks down then things could turn uglier in the days to come.

A decisive break of 3285 support would expose the 61.8% Fibonacci retracement level of the most recent upswing for a test, at 3170. The long-term bullish trend line comes in just below this Fibonacci level, making it an important technical area to watch going forward. On the upside, the previous reference points such as 3375 and 3485 are the key resistance levels to watch now. But as things stand, the path of least resistance is clearly to the downside now.