Is There Ever A Bad Time For A Good Hedge?

It’s “awfully early” for this discussion, and BofA’s Michael Hartnett readily admits as much — “awfully early” is a direct quote.

And yet, it’s worth noting that amid egregious underperformance from secular growth favorites and pandemic winners alongside an almost panicked catch-up bid in energy and banks, utilities and staples now comprise just 9% of the S&P.

The simple figure (below) shows you index weightings and YTD performance.

Obviously, the picture looked quite a bit different in 2020, as tech surged and energy languished. Note that staples and utilities look uninspired.

Of course, staples and utilities are “uninspired” by nature, but it could be that once the manic, hair-on-fire rotation into what Goldman’s David Kostin last week called “quintessential value sectors” runs its course, owning defensives will look smart.

Why? Well, BofA’s Hartnett sketched the contours in his latest, noting that over the past six months, the 100bps+ backup in yields has put a dent in credit, tech, and EM, while the cyclical rotation into banks, energy, and small-caps “has worked like a beauty.” But that’s behind us, or at least part of it is. The next stage, assuming the macro regime evolves as expected, could be more volatile.

“If the macro boom consensus is correct, then yields [may] move up another 50-100bps,” Hartnett said, suggesting that such a move in rates may engender higher volatility. At that juncture, defensives would make a “good market hedge,” he wrote. In the second half of this year, they could provide a measure of protection at the macro level “as global PMIs and US consumer spending peak.”

For what it’s worth, the 9% figure mentioned here at the outset is (basically) a three-decade low.

“Defensive industries generally trade at the lowest valuations in the market today,” Goldman’s Kostin remarked last week, adding that if you’re looking for sectors that screen “cheap” versus both their own histories and the index, staples, communication services, and healthcare stick out.

“Defensives should carry a discount in an economic environment of improving growth and rising rates,” Kostin went on to say.

Again, it may “awfully early,” as Hartnett put it. But Is there ever a “bad” time for a “good” hedge?


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