The Cac 40 feverish but still an important support on the 5,800 points, Index trading strategy

The markets had to understand that the Fed’s commitment to bringing inflation back to 2% was not being tested after a somewhat softer-than-expected speech from Jerome Powell at the Fed at the end of July. For the record, after its intervention in July, equity indices had jumped and US short rates had fallen (especially the 2-year rate, sensitive to the whole inflation/central bank theme). Communication error or strategy to relax the markets a little?

In any case, several members of the FOMC were, in the process, publicly surprised by the optimistic reaction of the markets after the meeting, recalling that the fight of the monetary institution against inflation was far from won, that it would take several months of slowing prices to begin to soften the Fed’s stance that rates were not going to be raised but quickly adjusted downwards. And, as if to correct the situation, Jerome Powell’s communication was pithy, expeditious and unequivocal in Jackson Hole. And the markets got the message, with the 2-year rate rapidly rising again to reach its highest level since… 2007.

The Cac 40 suffered a heavy relapse of 400 points in a straight line in stride. But, at this stage, the essential is preserved for the Cac 40, namely the support zone located between 5,600 and 5,800 points. This zone is formed by the presence of three oblique supports formed for several years. The fall of March, then that of June, was cushioned by one of these oblique supports. And if he were to give in, there would be two others less than 200 points apart.

It is necessary to recall that the test of this zone took place in a context of accumulation of many risks: high inflation and monetary normalization, start of the war in Ukraine, confinements in China and slowdown in global growth. However, despite these proven risks, in which the Cac 40 has been “bathing” for several quarters, this zone has triggered strong rebounds in the French index on two occasions.

For this zone to give way, there would have to be a risk that has not yet been identified or whose probability of occurrence until now was not considered sufficiently high, a kind of “Lehman” event that arises at a time when the overall risk seemed manageable.

But in the absence of a “Black Swan”, this support zone between 5,600 and 5,800 points still seems to constitute a zone of opportunity in the medium term, able to absorb waves of stress. The Cac 40 is “paying” just 10 times the profits today (against 12 times for the Dax or the EuroStoxx 50). If we look at the United States with the benchmark S&P 500 index, the latter is paying 19 times profits (compared to 36 times profits last year), thus returning slightly below its average valuation of last 10 years.

Post-Covid valuation excesses have therefore been corrected in Europe and the United States. However, we can raise the question of valuations if Europe or the United States entered a real recession, due in particular to the geopolitical context, monetary tightening and the slowdown in China.

We can still see that, faced with the worst-case scenario, with wholesale electricity prices soaring to more than 1,000 euros/MWh, the Cac 40 did not sink below the support zone mentioned above.

The “game changer” for the Cac 40 as for most European indices is geopolitics. An easing on this front would probably mark the end of the troubles for equity markets, as it would have immediate implications for rates, commodities, monetary policies, business confidence, etc.

An absence of new major deterioration on the energy front, without necessarily an immediate improvement, could all the same allow the Cac 40 to preserve this major technical zone because the valuation multiples have also been (partly) already adjusted against this risk has been present for months now.

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