For Stocks Pumped by Draghi’s Stimulus, The Only Way May Be Down

LAGOS (Capital Markets in Africa) – Ahead of this week’s European Central Bank meeting, investors mostly see the region’s equities weathering President Mario Draghi’s tapering signals. But in the short term, there are signals aplenty that the shares may be ripe for a pullback, particularly if the euro resumes its rally. Strategists on average now expect the Euro Stoxx 50 to decline by year-end. Here are five charts that indicate overheating in the stock market.

Euro-area stocks are no longer as cheap as they used to be on the basis of members’ book value. The Euro Stoxx 50 trades at a multiple of 1.6, the highest reading since April 2015. While there’s no exuberance in the region’s valuation levels at this point, with the ECB and Federal Reserve meetings looming, “it’s not the time to add to stock portfolios,” said Florent Brones, chief investment officer at BNP Paribas Wealth Management.

Germany’s DAX Index has had a strong run in recent weeks, reaching a record high in October. The gains have masked a “bearish divergence” in its relative strength index, a momentum indicator. The pattern usually signals an imminent pullback. “Investors have to be careful not to buy right now — they have to put long positions on hold,” Valerie Gastaldy, technical strategist at Day by Day, said.

Despite risks ranging from the Catalan crisis to North Korea, European investors appear barely concerned, judging by the region’s volatility gauge. The VStoxx Index last week fell to its lowest level on record. The measure, which has jumped above 30 on various occasions in the past two years, is still near levels it was at before Catalonia’s referendum. This shows a certain level of investor complacency, Alexandre Baradez, chief market analyst at IG France, said.

For equity investors, the main move to watch during the ECB meeting will be that of the euro, Nicolas Cheron, head of market research at Binck.fr, said. The single currency has been quite resilient since the Catalan referendum, and could resume the rally that stalled in September if Draghi’s announcement is perceived as slightly hawkish, according to him. “Given the strongly negative correlation between the currency and the stocks, if the euro goes up, stocks won’t go anywhere,” Cheron said.

Industry groups in the Stoxx Europe 600 Index have been exhibiting signs of overheating, especially carmakers. A gauge of auto-related stocks has been in overbought territory since mid-September, and has started to lose steam after reaching a peak on Oct. 18. Analysts at Bank of America-Merrill Lynch downgraded their rating on the sector to underweight from neutral on October 10, citing the stocks’ brisk rally since August.

Source: Bloomberg Business News