Wall Street’s Hedging Craze Gets Second Wind After 2024 Misfire
1 / 3
Wall Street’s Hedging Craze Gets Second Wind After 2024 Misfire
Denitsa Tsekova and Vildana Hajric
4 min read
(Bloomberg) -- In the euphoric markets of 2024, the biggest sin was skepticism. A white-hot runup in risky assets made life miserable for anyone buying into the frenzy of fresh products that Wall Street was hawking to hedge and diversify.
Three weeks into this year’s market whiplash, it’s starting to look like the sales pitch was simply too early. Big, lockstep moves have become the norm on the eve of Donald Trump’s inauguration. The latest example: this week’s stock-bond rally comes right after an equally large swoon just last week, marking the biggest reversal of its kind in 18 months.
Fueling the choppy market moves is febrile sentiment in the bond market, with the asset class jumping on economic data surprises to a largely unprecedented degree, according to TD Securities. Chalk it up to the lingering fear of inflation just as the incoming commander-in-chief’s policy agenda threatens to complicate the fiscal and trade outlook.
A notable antidote to the cross-asset churn has been a broad palette of securities marketed to investors for their defensive qualities. A cohort of exchange-traded funds tracking the likes of real estate and commodities, for example, are up more than 6% so far this year, trend-following vehicles are powering ahead of US stocks, and derivatives-powered products are getting billions in inflows.
“We will likely see an increase in investors requiring portfolio hedges in 2025,” said Paisley Nardini, asset allocation strategist at Simplify Asset Management. The reasons are “heightened interest rate volatility and geopolitical risks that may be exasperated with the incoming US protectionist administration.”
Hopes that the buy-and-hold mantra that followed Trump’s election will reassert itself got a boost over the last five days when the S&P 500 soared 3% and an ETF tracking long-dated Treasuries jumped 2%, the best showing in six weeks. But the concerted gains followed five straight weeks of losses for the combination, the worst streak since September 2023.
Unified moves like those are turning diversification trades that proved too fancy last year into what seem like reasonable alternatives, for now. Among them are funds that assemble a hodgepodge of away-from-the-mainstream assets like gold, natural resources and real estate — strategies designed to benefit should inflation in goods or services accelerate.
The AXS Astoria Real Assets ETF (PPI) is up more than 6% and the VanEck Real Assets ETF (RAAX) has gained about 5% year to date, for example. Elsewhere, the Simplify Managed Futures Strategy ETF (CTA) — a trend-following ETF buying the likes of bonds and commodities on the way up and selling them on the way down — has added roughly 3% this year.
The fund has doubled its assets in the past four months. Derivatives-based funds, many of which promise shelter when times get tough, are continuing to lure investors. This breed of complex ETFs took in $10 billion in the past three months alone, according to Bloomberg data. So-called covered call and buffer ETFs — favored for their defensive tilt — have taken the bulk of the inflows.
More straightforward hedges are doing well. A slew of investing styles that aim to hold up in a rising-rates environment, including the Simplify Interest Rate Hedge ETF (PFIX), have also been outperforming stocks.
“We are no closer to resolving many of the issues challenging the bond market that resulted in one of the weakest end-of-year results in several decades,” said Marvin Loh, senior macro strategist at State Street Global Markets. “Investors have chosen to shun the asset class until it can get a handle on fiscal and inflation concerns, keeping bond asset allocations below historical averages, behavior that is unlikely to change given these nagging, but important questions.”
Economic data and announcements about the policies of the incoming administration have been putting more pressure on macro-focused investors. Last Friday, hotter-than-expected jobs data sent stocks and bonds tumbling in unison — only for a slowdown in inflation to send markets to their best concerted cross-asset advance since at least late 2023.
“Investors need to be ready for higher volatility both in data and markets because we are likely to see sizable policy changes that alter the rules of the game,” said Rich Kelly, head of global strategy at TD Securities.
Donald Trump is set to take his oath as the next US president on Monday. While this means that policy announcements may have more power to roil markets, traders have been focused on the potential of the new administration to boost the already strong economy by tax-friendly policies and rolling back regulations for favored industries.
To John Davi, founder of Astoria Advisors and portfolio manager for PPI, the growing demand for alternatives is not necessarily a sign of investor worry pure and simple. Instead, it could be a bet that the economy is stronger than anticipated, allowing investors to ease away from concentrated stock bets.
“It’s the calendar-year turn. People are like, OK, growth is expensive, Mag 7 stocks had a tremendous year,” Davi said in an interview. “But if you’re constructive on the markets, it makes sense to look elsewhere.”
