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(Bloomberg) — There’s at least one silver lining from this week’s drama on Wall Street and beyond: Key defensive investing strategies are alive and well — restoring faith in hedging trades that have misfired in recent years.
After failing to live up to their protective mission in the 2022 rout, Treasuries have rallied throughout the stock meltdown, taking their 60-day correlation with the S&P 500 ever closer to the negative territory that signals they’re hedging equities again.
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For quants that slice and dice stocks by particular characteristics, so-called quality companies have been relatively resilient. One low-risk investing style tracked by a Dow Jones index jumped to its highest in more than a year on Monday.
All this offers a modicum of solace for traders reeling from the global market gyrations. And it compares favorably with the dark days of the Covid rout, when defensive trades and regular investing patterns went awry.
In Tuesday trading, equities advanced after the worst S&P 500 rout in almost two years.
“Strong bond performance will at least help to limit some of the portfolio deleveraging and ease selling pressure from balanced funds,” UBS Group AG derivatives strategists led by Pete Clarke wrote in a Tuesday note before the US market open. “Flows have remained constructive, with clients generally monetizing hedges and buying dips.”
At the same time, classic tail-risk hedges in the options market showed their worth Monday during the epic volatility spike — a stark contrast to 2022, when such strategies proved powerless against the slow grind lower in global markets.
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After the three-day stock swoon — culminating with the S&P 500’s 3% slump on Monday — investor sentiment is febrile amid fears the US economy is slowing and the AI hype is fading. Still, big investors are keeping their heads, trusting to defensive plays.
Brian O’Reilly, head of market strategy at Mediolanum International Funds, points out that cyclical sectors like industrials, energy and materials were among the better performers Monday — hardly the pattern of an equity market girding for imminent recession. He reckons as calm returns investors will start shifting money into late-cycle trades like quality and low volatility.
“We wouldn’t be throwing in the towel just at this point saying, we’re at the end of the cycle,” O’Reilly said from Dublin. “I think what we’ll see going forward is institutional investors feeling more confident to look outside tech, communication services, AI.”
At 22V Research, economist Gerard MacDonell says market valuations aren’t signaling widespread fears of a recession, just yet. For the Federal Reserve, while equities have plunged, other financing channels — anticipating a likely rate cut in September — aren’t in crunch mode.
“Neither the levels nor the changes suggest that the market is priced for macro drama, although pricing has moved to discount darker sentiment,” MacDonell wrote in a note. “I do think the Fed would more likely welcome than protest some heat coming out of the equity market, with a bit more support being offered from the bond market.”
—With assistance from Isabelle Lee.
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