European equities began the week with a cautious mood, reflecting a more tentative outlook. The Eurostoxx, Germany’s DAX, France’s CAC, and Spain’s IBEX each fell by 0.4%, while Italy’s FTSE MIB dipped 0.2%.
Despite the declines, the DAX maintains slight gains for the month. Meanwhile, the benchmark indices for Spain and Italy remain just off their highest levels in nearly two decades. UK markets are closed for the day, contributing to a quieter atmosphere with the absence of activity in London. In the US, S&P 500 futures saw a slight decline, down by 0.1%.
Cautious Start to the Week
We are seeing a cautious start to the week in European markets, and this slight downturn is a signal to review our positions. With indices in Spain and Italy coming off highs not seen since before the 2008 financial crisis, it is a prudent time to consider protective strategies. Buying put options on the Eurostoxx 50 or on individual country indices like the FTSE MIB can lock in some of the significant gains we’ve seen this year.
This tentative mood suggests an increase in market volatility may be on the horizon after a period of calm. The VSTOXX, which measures Eurozone equity volatility, has ticked up to 16.2 this morning, a noticeable jump from the lows around 14 we saw earlier in the month. We can use VSTOXX futures or options to position for a further increase in market turbulence over the coming weeks.
This pullback isn’t happening in a vacuum; it follows last week’s flash Eurozone CPI data, which came in at 2.8%, slightly above expectations and still stubbornly above the ECB’s target. This keeps the pressure on the European Central Bank ahead of its September meeting, making markets nervous about the possibility of another rate hike. This uncertainty is likely to cap any significant upside for equities in the short term.
Strategies Amid Uncertainty
The German DAX is holding its monthly gains for now, but we are mindful of recent data showing a continued slump in German manufacturing orders, which fell by 1.3% last month. This economic weakness in Europe’s largest economy contrasts with the market’s recent highs, suggesting a potential vulnerability. A pairs trade, such as being long a more resilient index and short the DAX, could be a strategy to consider.
With month-end approaching and London out for a holiday, liquidity is thinner, which can exaggerate market moves. This is a time for caution, not for opening large new directional bets. Selling out-of-the-money call options, a strategy known as selling covered calls, could allow us to generate extra income from our existing long positions while we wait for a clearer market direction to emerge.
