Under the influence of aggressive interest rate hikes by the Federal Reserve and fears of a recession, the S&P 500 fell into a bear market after plunging more than 20% from its highs at the beginning of the year.
However, the U.S. PMI data on Thursday poured cold water on the Fed to raise interest rates, and the market’s expectations for interest rate hikes have cooled significantly, making the S&P 500 index its biggest gain in two years this week.
The traditional hedging tools that worked in the U.S. stock market rout in the past are now failing due to recent volatility in investor expectations for rate hikes.
Generally speaking, investors can use stock index futures, options and Treasury bonds to hedge, or use sentiment to identify market bottoms.
However, the sudden rebound of US stocks this week and accelerated upward, not only reversed the momentum of the three-week losing streak, but also made investors who use hedging tools pay a high price.
Hedges like puts, bearish sentiment and Treasuries fail
Recently, with the exception of the S&P 500’s 5% put options, other hedging tools have also failed.
For example, in the first half of this year, the overall U.S. stock market fell sharply. In the past, in the process of investors selling frantically, extremely pessimistic market sentiment would be regarded as a signal to buy against the trend, but now the volatility of market sentiment makes the bearish sentiment reading inconsistent. Works again.
Also failing are government bonds, which investors used to hedge against in past bear markets, but now that hedge has also failed.
Take the iShares 20+ Year Treasury Bond ETF as an example. During the 2020 stock market crash and the 2008-2009 financial crisis, the fund’s returns were 14% and 18%, respectively, but the fund has fallen 24% this year, more than the S&P. The 500 index fell even more.
In this regard, John Flahive, head of fixed income investing at BNY Mellon Wealth Management, said:
We are in unusual times and one of the reasons traditional hedging tools fail is that interest rates are being manipulated and what we have experienced in the first half of the year is this period of (interest rate) adjustment and the friction (repeatedly) created by this change .
Why are U.S. stock hedging tools no longer effective?
Some analysts believe that the unexpected failure of these hedging tools is because “the selling trend is often interrupted by the rebound trend.”
This counter-trend rally has slowed the pace of the broader U.S. stock market downturn, making it harder for investors to profit from out-of-the-money puts.
Goldman Sachs strategist Rocky Fishman explains:
We can compare this to a policy with a deductible, let’s say every month your house is damaged, but only moderately, so you can’t claim a lot from your insurance company every time, but you’re paying all the time Premium.