All Eyes Still on Europe

The US equity market remains headline-driven, but the market moving news flow isn't economic data or earnings. Events on the other side of the Atlantic have become the primary drivers for volatility in the US stock market. Today, for example, weakness across the Eurozone and the euro is weighing on Wall Street, despite better-than-expected domestic economic news. The Dow Jones Industrial Average (.DJI) is under water. Indeed, the events in Europe are having a big impact on the US equity market and creating a volatile environment heading into a historically turbulent month for the US equity market.

The domestic economic news has seen some improvement over the past two days. Friday, data showed the Chicago PMI, a gauge of regional manufacturing activity, up to 60.4 in September, from 56.5 in August, and much better than the 54.0 that was expected. At the same time, the University of Michigan Consumer Sentiment index improved to 59.4, from 57.8 in mid-September and better than the 57.5 that was expected. Data released Monday also surprised to the upside. The ISM Index of manufacturing activity rose to 51.6 in September, from 50.5 in August and ahead of the 50.6 that economists had predicted. Meanwhile, Construction Spending was up 1.4% in August. The rocket scientists were looking for a decline of 0.5%!

The strong data failed to lift the US equity market. Instead, the Dow Jones Industrial Average is down 194 points midday Monday and has given up 434 points over the past two sessions! The primary concern is the negative impact from the European debt crisis. Investors fear that debt defaults would hurt banks, roil equity markets, and drive the Eurozone into a deeper recession - or worse. Europe is an important trading partner to the US and the banking systems are closely tied.

Equity markets are already reeling across the Eurozone. One month ago, before the Labor Day holiday, I noted (in Seven Trends to Watch Tuesday) that the action in the iShares Germany Fund (EWG) will be worth watching. Shares hit a 52-week low of $19.53 on August 19 and we wanted see those 52-week lows hold after the three-day weekend. If not, "expect the volatility across the Atlantic to spill over onto US shores next week."

EWG failed to hold the support lows around $19.50 in early-September. Trading has been volatile in the weeks that followed. Shares are down 10.6% over the past month. Now, we can see from the chart (below), the previous support area has become a source of resistance. Keep in mind, EWG is a US-listed product composed of shares of German companies. Yet, the chart shows a textbook example of an old rule of technical analysis - previous support areas often form resistance and vice versa. Now, the chart pattern is possibly developing into a reversal - triple bottom or upside head-and-shoulders. However, until shares can break above the previous resistance around $19.50, it's obviously too early to call a bottom in Germany's equity market.