4 min read.Updated: 31 Oct 2020, 01:13 PM ISTJoe Wallace, The Wall Street Journal
Investors worry that a lack of protection from traditional safe havens leaves them exposed during the U.S. election and an upsurge in Covid-19 cases
Investors found few places to shelter when stocks tumbled this week, illustrating the limitations of traditional havens following a run-up in prices across markets.
Lockdowns in Europe and rising coronavirus cases and no agreement on a second round of government stimulus in the U.S. have shaken confidence in the world’s economic revival, putting the S&P 500 on track for its worst week since March. Government debt and gold, which many investors own in the expectation they will zig when stocks zag, haven’t acted like the safety net to which investors are accustomed.
Money managers worry that a lack of protection from traditional havens leaves them exposed if stocks gyrate through a period spanning the U.S. election and potential upsurge in infections. Efforts to find new hedges in commodities, currencies and derivatives as well as more esoteric, less liquid markets gained new urgency during this week’s selloff.
The market swoons on Wednesday, the worst down day for the S&P 500 since June, and Friday, were cases in point. On both occasions, Treasurys barely budged and gold either fell or edged higher.
“The only thing that protected you was cash and that’s not giving you any return," said David Bowers, co-founder of London-based Absolute Strategy Research, which advises investment firms. “Both bonds and equities are overvalued at the moment…This is potentially quite a challenging environment."
In the past, yields on U.S. Treasurys would often fall when stocks took a tumble. Since yields move inversely to bond prices, this alleviated losses for investors.
Recently, though, government bonds have done little to cushion the blow. Yields on 10-year Treasury notes stood at 0.86% Friday, marginally higher than at the start of the week, in contrast to a 5.7% retreat for the S&P 500.
Some investors say yields simply can’t fall much further after a yearslong slide driven by persistently low inflation, loose monetary policy and an aging population. That decline accelerated earlier this year when the pandemic threatened to disrupt the economy. The Federal Reserve cut interest rates and began to vacuum up bonds in an attempt to keep borrowing costs low and backstop growth.
“Government bonds, considering the low level of interest rates, aren’t sufficient to protect a portfolio," said Samy Chaar, chief economist at Swiss private bank Lombard Odier.
American investors are grappling with a challenge European fund managers have faced for several years, according to Mr. Chaar. Ten-year German government bonds yields were negative before Covid-19 and haven’t fallen as far as Treasury yields since its onset, he said.
The prospect of a new round of stimulus after the Nov. 3 elections is also preventing U.S. bonds from acting as an effective hedge, said Andrew Brenner, head of international fixed income at NatAlliance Securities.
Treasury yields rose in recent weeks alongside Joe Biden’s poll lead, which raised expectations of a Democratic sweep that smooths the path to a second spending package. Higher deficits can boost yields by increasing the supply of bonds while lifting growth and inflation.
Mr. Brenner thinks there will be major stimulus no matter the outcome.
“There’s too much [bond] supply coming, whatever color you want: A blue wave or a red tide," he said. He thinks 10-year yields could rise back to 1% in the coming months and that cash is the best hedge against stocks right now.
If bonds provided little insulation this week, gold gave none at all, falling 1.2% to $1,881.70 a troy ounce.
Gold is behaving like a risky asset following a rally that pushed its price to record highs in August, said Tai Wong, head of base and precious-metal derivatives trading at BMO Capital Markets.
“If you’ve been using gold to hedge your equities in recent months it’s been a Texas hedge," Mr. Wong said, referring to a position that increases an investor’s risk.
That raises the possibility that when stocks sell off, the precious metal will go with them as investors liquidate assets to raise cash and meet margin calls, a dynamic that played out in the March pandemic panic. There wasn’t clear evidence of forced selling this week, commodities traders said.
Gold faces two other obstacles in working as a counterweight to stocks, according to John Roe, head of multiasset funds at Legal & General Investment Management. The metal is denominated in dollars and so moves inversely to the U.S. currency, which strengthened during Wednesday’s selloff. It is also sensitive to real bond yields, which are calculated by subtracting anticipated inflation from a bond’s yield. These edged higher in response to falling inflation expectations.
To find new hedges, Mr. Roe said LGIM is placing wagers against trades it thinks investors have crowded into and are likely to unwind when stocks go into reverse. Right now that means betting against the Korean won, investment-grade corporate bonds and five-year U.K. inflation swaps.
“It’s very difficult to insulate portfolios right now," said Adam Taback, chief investment officer at Wells Fargo Private Wealth Management. “More tools are needed to navigate this environment."
Investing in infrastructure or private real estate can reduce investors’ exposure to day-to-day swings in stock prices, Mr. Taback said.
Write to Joe Wallace at Joe.Wallace@wsj.com
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