There’s something tautological about maintaining a “pro-risk asset allocation” until “risks” to that view materialize.
I mean, that’s kinda like saying “I’m maintaining my sunny day outlook until clouds start to show up.”
That said, I guess it’s reasonable to remain some semblance of optimistic on risk assets in general and equities specifically given that the growth outlook is still pretty solid globally and although we’re late cycle in the U.S. (and although President Dennison’s fiscal folly seems destined to pull forward the end of cycle by giving an adrenaline shot to an economy already operating at full employment), there’s still not much in the way of convincing evidence that things are going to go imminently off the rails (default rate forecasts are still benign, etc.). And then there’s the buybacks, expected to clock in at between $650 billion and $850 billion this year thanks in no small part to the tax plan – so that’s a literal “plunge protection” bid and it was evident last month.
With those obligatory caveats out of the way, there are obviously a set of readily identifiable risk factors on the horizon including, but certainly not limited to, the possibility that the synchronous upturn in global growth slows down (or at least becomes less synchronized), Trump accidentally stumbles everyone into a trade war (and I use “accidentally” there to reflect the distinct possibility that he’s just using the tariffs as a political gambit ahead of the midterms) and the possibility that rates rise rapidly.
For their part, Goldman thinks all three of those risks should be actively hedged.
On the growth slowdown risk, the bank writes that because literally everything is expensive (diversification desperation) “hedging growth risk will increasingly need to be done by directly hedging downside risk in the growth asset equities.”
Goldman says if you’re asking them, they’d “buy correction hedges at times when vol resets lower” and they think that if you’re sniffing around in that regard, it might be worth noting that the VSTOXX “is now at one of its lowest levels ever compared with the VIX”:
Moving on, Goldman considers the trade war scenario and notes the obvious which is that it’s impossible to know how to hedge that because gaming out all the possible second-order effects and trying to figure out what Trump would or wouldn’t do in a given scenario is an exercise in futility. But they like the inflation angle.
“One trade war hedge we like is long breakeven inflation,” the bank writes, adding that “in the case of trade war escalation, inflation expectations could rise as supply chains and competition are disrupted, and uncertainty about inflation could rise, increasing inflation risk premium as well [and] given late cycle pressures our base case expectation for breakeven inflation is also to the upside.”
You’ll recall that according to BofAML’s most recent rates and FX strategy survey, most fund managers would rather just short stocks. Recall this, from our piece last week:
As BofAML notes, “investors are unsure about how to position for tariff threats in rates and instead view equities and the USD as the more obvious plays.”
Right. And remember, there’s more than a little ambiguity about what the tariff threat means for the dollar because while the models say one thing, real-world experience (i.e. the fallout) tells a different story. In light of that, folks are overwhelmingly predisposed to just short stocks:
Finally, Goldman has the following to say about higher rates:
Rising rates: We think further rate repricing will cause tighter financial conditions and hence lower long-term growth expectations. As a result, rising rates could be disruptive to risky assets, depending on how they rise. Rate volatility continues to appear too low to us, particularly for intermediate maturity bonds. After the pick-up in rate volatility in January, rate vol has again returned to levels it was at towards the end of last year. As a result, we would position for 10-year yields rising above the forwards and for rate vol to rise, which could weigh on risky assets.
So there you go. Bring an umbrella.
Or maybe not. Because if it never rains, umbrellas are just a pain and in the ass and when it comes to markets, they’re often expensive and more annoying still, are prone to expiring worthless.
Finally, here’s a picture of an umbrella and some rain, because today I’m going to do that thing that other bloggers do where they put a picture in an article that reflects the headline even though it’s silly because it’s not like anyone has forgotten what an umbrella looks like. Or in the market context, maybe you have.