Taking out protection proves its worth

Thought of the day

by Chief Investment Office 03 Apr 2018

The S&P 500 once again slid into correction territory on Monday, having fallen more than 10% from its late January peak. And global equities have now had their worst three months in more than two years.

But investors can consider positions that protect against renewed volatility and tail risks, without surrendering upside from strong economic and earnings fundamentals by exiting the market.

  • US government bonds can help offset stock market turmoil. The yield on 10-year US Treasuries is down from its February peak of 2.95% to 2.75% (with the value of bonds rising as yields fall.) We believe 10-year Treasuries offer value given the extent of the rise in yields since September and our view that the Federal Reserve will raise rates only gradually. While stocks and bonds can fall in tandem, as they did during February’s equity correction, Treasuries typically provide a hedging benefit when stocks are falling.
  • Certain currencies, such as the Japanese yen (JPY), typically rise in value in periods of heightened risk aversion. This is especially the case relative to the currencies of economies highly vulnerable to a global economic slowdown, such as the New Zealand dollar (NZD). Since late January the yen has climbed 5.7% versus the NZD.
  • Investors can also consider buying downside protection on part of their equity holdings in the derivatives market.

So, while we expect markets to recover as investors return their focus to strong global growth and corporate earnings, recent developments underline the wisdom of phasing protection into portfolios in the late-cycle period of a market rally.

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