The relentless spread of the delta variant. Warnings on growth for the world’s two biggest economies. Geopolitical risk as Afghanistan falls.
An outbreak of bad news is spurring cautious investors to double down on cross-asset hedges as risk markets hold near record levels, while currency traders move into havens.
Investors in exchange-traded funds are pushing a measure of protection against a downturn in junk bonds to the highest level since March. Stock-volatility traders are piling on hedges. Companies that boomed in the stay-at-home era are rising again.
In a global market that’s absorbed every blow and soared to new highs, even just a few signals flashing caution are proving conspicuous to Wall Street traders.
“If we are going to have an issue with growth, then equity and credit will take the full surprise on the chin,” said Ludovic Colin, a senior portfolio manager at Vontobel Asset Management.
Read more: Smart Money Had the Jump on Another Mid-Month Plunge in S&P 500
Alongside a slump in U.S. consumer confidence to an almost decade low and increasing supply chain pressures in southeast Asia, a slew of economic reports from China underline the potential havoc the more contagious delta virus variant could have on the global recovery.
“The slowdown risk in China is very much underappreciated by markets,” said Bob Stoutjesdik, a fund manager at Robeco Institutional Asset Management. “There is some pain to be felt if the consensus view does not live up to expectations, and we are seeing some evidence that it isn’t.”
The S&P 500 Index tumbled Tuesday in the worst drop in a month, with benchmark Treasury yields trading near multi-month lows seen in early August. Further declines in long-term yields are at the heart of Stoutjesdik’s strategy. He’s selling credit and buying long maturity debt betting that the yield curve in developed markets will flatten as growth sputters.
Read more: Treasuries, Dollar Dominate as Geopolitics Add to Virus Tremors
This week, currency traders have been moving into havens and out of regions where new Covid restrictions were about to be imposed. That was epitomized by New Zealand, where a single case of the virus triggered a nationwide lockdown.
Meanwhile, booming credit markets mask rising demand for options that pay off if the iShares High Yield Corporate Bond ETF declines. Open interest for put contracts on HYG have climbed to 6 million contracts, near its March peak.
While that may underscore appetite to hedge risk-on portfolios, the same cautiousness can be seen in stock derivatives.
Credit Suisse Group AG is seeing “a pick-up in hedging interest” for the S&P 500 Index ranging from one to three years. Demand for long-term protection has steepened the gauge’s term structure -- which tracks volatility expectations for the future -- to a nine-year high, according to the bank.
Other metrics, like skew and option demand on the Cboe Volatility Index, are also showing signs of fear beneath the surface. That’s despite the relative calm over the near-term “with Jackson Hole now expected to be a non-event and the summer lull in full swing,” according to Mandy Xu, chief equity derivatives strategist at the bank.
Meanwhile, an index of stay-at-home shares have also been beating stocks linked to the re-opening trade such as airlines and hotels.
For Christian Mueller-Glissmann, managing director of portfolio strategy and asset allocation at Goldman Sachs Group Inc., heady market gains in the first half were always going to be a hard act to follow in the second half. He’s optimistic about the recovery but sees risks from data disappointments to tighter policy along the way.
His advice is to counterbalance exposure to cyclical stocks with defensive safety plays.
“There is still a strong case for hedging,” Mueller-Glissmann said.
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