Wall Street’s Great Rotation Trade Is Stirring Up Hedging Market
On Wall Street, big trades that have held sway for years are getting reshuffled as the monetary and political backdrop shifts.
![The reach for hedges comes as investors shower money on previously left-for-dead strategies in the era of elevated interest rates.](https://media.assettype.com/bloombergquint%2F2024-07%2Fe38e373a-c2ad-4038-91fc-76cabf410ba5%2F_1x_1.jpg?auto=format%2Ccompress&w=200)
(Bloomberg) -- On Wall Street, big trades that have held sway for years are getting reshuffled as the monetary and political backdrop shifts.
Now traders are hastily rushing to the options exchanges, paying up to protect — or juice — their portfolios after a turbulent week in the world’s largest stock market.
With the election cycle kicking off in earnest, demand for portfolio insurance in the event of a market crash is surging, as so-called tail-risk contracts register their biggest rise in costs all year.
A broad measure of equity volatility has also increased at the fastest weekly pace since March 2023, just as investors have been plowing record cash into exchange-traded funds tracking the S&P 500. Previously money-minting derivatives bets on tech bastions such as Nvidia Corp. are being abandoned with gusto.
The reach for hedges comes as investors shower money on previously left-for-dead strategies in the era of elevated interest rates like small-cap companies. All in, it’s a tentative shake-up of the winners and losers, one that potentially echoes previous turning points for markets and the economy.
“There is certainly an inflection point in sentiment,” said Amy Wu Silverman, head of derivatives strategy at RBC Capital Markets LLC. “You are actually seeing demand for hedging in stocks like NVDA.”
![Wall Street’s Great Rotation Trade Is Stirring Up Hedging Market](https://media.assettype.com/bloombergquint%2F2024-07%2F4366fb6d-025e-4da5-84d6-838fa9531dc4%2F_1x_1.png?auto=format%2Ccompress)
Politics explains some of the swings, with traders warming to Donald Trump’s improving presidential odds. Yet the rotation began in earnest days before he survived an assassination attempt, just after June’s consumer price index rose less than forecast. Weakening inflation has boosted demand for economically sensitive sectors on bets the Federal Reserve has room to cut interest rates and lower burdens on debt-financed industries.
Retrenchment and reallocation were the themes in a week that saw the biggest single-session drop in the tech-heavy Nasdaq 100 since 2022 and the third straight fall for the S&P 500. Despite dropping Wednesday through Friday, a rally in small-cap shares has put the Russell 2000 on pace for its best month of 2024. US junk bonds just scored their longest winning stretch since 2020. The Cboe Volatility Index, known as the VIX, reached near 17 — the highest level since April.
The week was especially rough for the megacap cohort whose sway over benchmark indexes has tightened as gains accrued in their biggest members. The Bloomberg Magnificent 7 Index tumbled 4.8% on the week, a loss that dragged the cap-weighted S&P 500 to a 2% decline and spurred its underpeformance against the average constituent.
ETF Flows
Investors hoping to capitalize on that trade sent nearly $10 billion to small-cap funds through Wednesday, the second-most ever, just as demand reached a record for bullish options in the biggest ETF tracking the Russell 2000.
Value stocks flirted with their best two-week advance of the year, while junk bonds had their biggest inflow since November, at $4.4 billion, according to Bank of America Corp. citing EPFR Global data.
Still, beneath the risk-on sentiment, anxiety is growing. Demand for tail-risk hedges that pay out in a stock crash – perhaps as much as a 30% downturn — is rising at the fastest pace since October. The cost to protect against a retreat at around 10% or so is at the highest level since August 2023. Tech darlings like Nvidia, upon which options traders had feasted for months, saw demand for bearish puts outpace calls by the most in five months.
“It signals a different regime,” said Erika Maschmeyer, portfolio manager at Columbia Threadneedle Investments, who oversees more than $3 billion, said by phone. “The market could be choppier and more volatile, with more dispersion than we have seen.”
![Wall Street’s Great Rotation Trade Is Stirring Up Hedging Market](https://media.assettype.com/bloombergquint%2F2024-07%2F3177d3b3-f922-452a-bf64-91596d19dfe0%2F_1x_1.png?auto=format%2Ccompress)
Volatility may remain heightened with pressure mounting on President Joe Biden as top lawmakers publicly weigh his narrowing path to re-election.
A growing number of Wall Street pundits has also cautioned that the Fed is waiting too long to begin cutting rates as signs of an economic slowdown becoming more evident. With adjustments to rates taking a year or more to have impact on the economy, the risks of waiting are growing, Goldman Sachs Chief Economist Jan Hatzius and Renaissance Macro Research’s Neil Dutta have warned in recent weeks.
“There’s more uncertainty now entering the market,” said Lindsay Rosner, head of multi-sector fixed income investing at Goldman Sachs Asset Management. “You’ve got the Fed telling you they’re closer to a cut than they have been. You’ve got election situations ever changing.”
--With assistance from David Marino.
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