A winning streak for the S&P 500 that has generated 10 record closes in August alone has strategists split over what comes next. No wonder the buyside is adding defensive buffers as they ride a bull market like no other.
Just look at stock options. The S&P 500’s three-month skew—the cost of protective put contracts over bullish calls—has risen since the end of June, and is higher than the five-year average.
U.S. small-cap companies, which tend to be hitched to the economic cycle, are on track for the longest streak of underperformance since 2011 versus large-cap peers. Exchange-traded funds riding quant growth strategies are getting more cash this month than products betting on firms tied to the business cycle.
These are signs that risk-on investors are adding protective buffers as the delta variant spreads and Federal Reserve policy makers gather to discuss the tapering of stimulus at the Jackson Hole symposium.
While the S&P closed at a fresh record Wednesday, recent data show the heady growth of the first half of the year is cooling, with a measure of U.S. business activity slowing to the weakest in eight months.
“We are keeping committed to risky assets but with hedges in place because while macro-economic conditions are still resilient, there are issues that could hamper very high valuations,” Francesco Sandrini, senior multi-asset strategist at Amundi SA, said in an interview with Bloomberg TV. “We deem this environment very fragile. No doubt monetary conditions are affecting growth.”
Sandrini prefers credit as a hedge against the risk of a stock correction that he says could be between 5% and 7% in the short- to medium-term.
“It will not be a very deep correction,” he said. “But it’s the time where we need to have some hedges in place.”
Treasury benchmarks have rallied since the 10-year yield peaked at 1.77% in late March, with bond flows undeterred by a series of hotter-than-anticipated inflation reports.
Haven assets may be set for much bigger gains, if chartists at Bank of America Corp. are right. In a report this week, they projected Treasuries are at the start of an uptrend that at the same time signals a bearish phase for growth-sensitive stocks, oil and copper. Their conclusions are derived from two decades of trading patterns in U.S. bond futures versus the Russell 2000 and Bloomberg Commodities indexes.
Meanwhile, the underbelly of the stock-volatility market is sending cautious messages as the virus spreads and market valuations sit at elevated levels.
“Despite short-dated at-the-money implied volatilities falling, hedging activity—as determined by equity skew—has been very robust,” Man Group strategists wrote in a note this week.
—With assistance from Francine Lacqua, Justina Lee and Sophie Caronello.
This article was provided by Bloomberg News.