European stocks began the month on a downward trend, with most indices experiencing declines. The German DAX attempted a mid-week recovery but ultimately fell by 0.85% by week’s end, closing near its weekly low.
Daily losses occurred across major indices: Stoxx 600 decreased by 0.2%, France’s CAC by 0.4%, UK’s FTSE 100 by 0.1%, Spain’s IBEX by 0.6%, and Italy’s FTSE MIB by 0.9%. Over the week, the Stoxx 600 remained steady, losing 0.2%, while the German DAX decreased by 1.3%.
Weekly Market Performance
The French CAC managed a slight weekly increase of 0.1%, and the UK’s FTSE 100 rose by 0.2%. Meanwhile, Spain’s IBEX fell by 0.7%, and Italy’s FTSE MIB dropped by 1.4%. Overall, the markets ended the week in a subdued state.
This weak start to September is signaling to us that we need to prepare for more downside. With the German DAX and Italian FTSE MIB showing significant weakness, traders should be considering protective strategies. The most direct response is to buy put options on the Euro Stoxx 50 or the DAX to hedge existing long positions against a further drop.
The VSTOXX Index, which measures Euro Stoxx 50 volatility, has climbed over 15% this past week to touch 22.5, a level we haven’t seen since July. This rising fear gauge makes options more expensive, but it also confirms the growing uncertainty in the market. We believe that paying a higher premium for protection is justified in the current environment.
The DAX’s underperformance can be partly explained by Germany’s latest manufacturing PMI reading, which came in at 48.5, marking a second consecutive month of contraction. This economic softness, especially compared to the relative stability of the UK, presents potential for pairs trades. We are looking at shorting DAX futures while going long on FTSE 100 futures to capitalize on this divergence.
Inflation and Central Bank Policies
Underlying these moves is the persistent inflation problem, with the latest Eurostat data showing August core inflation holding at a stubborn 3.1%. This is keeping pressure on the European Central Bank ahead of its policy meeting later this month. The market is increasingly pricing in the risk of another rate hike, which is capping any potential upside for equities.
This market action feels very similar to the choppy conditions we saw in late 2022, when central bank uncertainty dominated trading. Given that September is historically a challenging month for stocks, a major rally seems unlikely. Selling out-of-the-money call credit spreads to collect premium is a strategy that aligns with our view of a sideways-to-down market in the weeks ahead.
