Here’s why you should care about German stocks

Markets around the world are getting rattled by what’s happening between Russia and Ukraine as well as the possibility of slowing economic growth in China.

Despite the fact that all of those places are thousands of miles away from America’s shores, they’re still having a profound impact on U.S. markets. Traders up and down Wall Street are pointing to a renewed sense of risk aversion.

The question becomes whether or not this is the beginning of that long-awaited correction for U.S. stocks. The last time the bears tried to press their case was around the middle of January through the first week of February. During that time, the S&P 500 dropped around 6 percent, but bounced back in relatively short order before reaching new record highs in early March.

Ralph Orlowski | Getty Images

Ralph Orlowski | Getty Images

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Of course, slowing growth in China and worries about Russia’s tense relationship with Ukraine were already festering. But some traders are paying even more attention to what’s happening in continental Europe for signs of what’s ahead for U.S. stocks.

They’re looking at Germany’s stock market. That nation has relatively close economic ties to Russia. The two are trading partners, so weakness in Russia’s markets will reverberate through Germany’s markets to a certain degree. In turn, Germany is an important trading partner with the U.S.

Matt Maley, an equity strategist at Miller Tabak, points out that there is a very high correlation, or trading relationship, between the value of the S&P 500 and Germany’s DAX stock index. In other words, the direction of both indexes seems to track each other fairly closely.

A look at the charts of both going back to 2009 demonstrates what he’s referring to. The reason for the concern is the far right-hand side of the chart. There is a sizeable divergence happening between the two lines. The DAX is now significantly lower than the S&P 500.

A closer look at the one-year chart of the two indexes highlights this gap in performance. If the historical trading relationship holds true, then either the DAX will bounce off its lows and catch up to the S&P 500, or the S&P 500 is due for a drop to match the downside performance for the DAX.

Hypothetically, in order for the DAX to trade more in line with the S&P 500, it would need to get back to a level of approximately 9,500, which represents an approximate 6 percent rise from current levels. On the flip side, the S&P 500 would have to trade down to around the 1,750 level if it were to match the current DAX level, which is a drop of around 5 percent.

Maley notes that the DAX currently sits at an important support level in the charts, meaning that a larger move below current levels may lead to accelerated losses. This is why many traders are keeping a close eye on Russia, Ukraine and China as well as market developments in Germany.

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It’s worth noting that the S&P 500 is just around 2 percent below its record highs, and even if it were to drop 5 percent from these levels, that would put the pullback at about the same level of the average stock pullback since the depths of the financial crisis.

Of course, if material changes happen to the current situations in Ukraine or China, all bets are off.

While there has been selling pressure on U.S. stocks, some traders note that there isn’t a sense of panic selling. They also note that the downside pressure isn’t a result of a massive flood of sell orders hitting the market. Rather, it’s been a lack of any real buy orders.

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With stocks near record highs, caution is still the prevailing sentiment. However, the trading relationship between German and American stocks is perhaps one reason why some traders are taking some profits just in case the global geopolitical or economic situation takes a turn for the worse.

—By CNBC’s Dominic Chu. Follow him on Twitter @thedomino.

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