Fed Chair Jerome Powell will speak at Jackson Hole today
Today the monthly and year-over-year PCE price index and core PCE price index are on tap. Traders also will be sifting through real disposable incomes, real consumer spending, nominal personal incomes, and nominal consumer spending data, as well as advance trade in goods. Lastly, the University of Michigan (UM) will release its final consumer sentiment index, and five-year inflation expectations.
The following public company is slated to release corporate earnings today, August 26:
JinkoSolar Holding Co. Ltd. (NYSE:JKS — $58.65) engages in the design, development, production, and marketing of photovoltaic products. JinkoSolar will report its Q2 earnings of 2022 before the bell today.
Looking ahead to next week, a handful of Federal Reserve officials will be offering remarks on the state of the economy. There will also be no shortage of economic indicators to unpack, as investors kick off September with a huge batch of manufacturing data.
The bear market on Wall Street is not a “black swan.” This is important is for semantic clarity, if nothing else. The term “black swan” has been thrown around with such abandon in recent months that it’s in danger of losing all meaning.
There’s a more important reason not call this bear market a black swan: it creates unrealistic expectations about what can be achieved with black-swan protection strategies. Those strategies hedge against certain rare events, but not everything bad that can happen in the stock market.
The black swan theory has a long history in philosophy and mathematics, but its use in the investment arena traces to the work of Nassim Nicholas Taleb, a professor of risk engineering at New York University. Taleb wrote a book in 2007 entitled “Black Swan: The Impact of the Highly Improbable,” in which he defines a black swan as an extremely rare and sudden event that has very severe consequences.
A key aspect of black-swan events, Taleb argued, is that they are unpredictable. This unpredictability means that, in order to protect yourself, you must always hedge your portfolio against the worst. That hedge will detract from your return in most years, but pay off in a big way in the event of a black swan.
A good analogy is to fire insurance on your house. House fires are extremely rare, but you still buy insurance against the possibility and are more than willing to pay your insurance premium.
Black-swan insurance in the investment arena pursues two general approaches. The first is to be as conservative as possible with almost all of your portfolio and extremely aggressive with the small remainder. The second is to couple your normal equity portfolio with an aggressive hedge — such as with deep out-of-the-money puts.
Neither of these strategies has offered complete protection against the current bear market, as you can see in the chart below. The three strategies listed in the chart are:
Swan Hedged Equity U.S. Large Cap ETF HEGD, -0.18%,
which invests more than 90% of its portfolio in large-cap stocks and hedges with put options.
Amplify BlackSwan Growth &Treasury Core ETF SWAN, -0.44%,
which invests 90% in U.S. Treasurys and 10% in S&P long-dated call options.
S&P 500 SPX, -0.34%
fund (96.67%) plus long-dated out-of-the money puts (3.33%). This specific strategy was derived by Michael Edesess, an adjunct professor at the Hong Kong University of Science and Technology, in an attempt to replicate the reported returns of a hedge fund (whose strategy is proprietary) with which Taleb is associated.
Clearly, all three approaches’ year-to-date losses are in the double-digits, with the Amplify BlackSwan ETF actually losing more than the S&P 500 itself.
Your comeback might be to suggest constructing portfolio hedges that insure against more than just black swan-like losses. But the cost of such hedges would be much greater than the insurance premium for protecting against a black swan. That cost could be so high, in fact, that you might decide it’s not worth it.
Consider fixed income annuities (FIAs), which allow you to participate in the stock market’s upside while guaranteeing that you never lose money. The “premium” you must pay for this insurance is that your participation rate — the share of the price-only gains that you earn — is often well-below 100%. Currently, for example, according to Adam Hyers of Hyers and Associates, a retirement-planning firm, an FIA benchmarked to the S&P 500 has a 30% participation rate — in effect setting its insurance premium to be 70% of the index’s gains in those years in which the stock market rises.
Would you be willing to forfeit 70% of the S&P 500’s price-only gains in years the stock market rises, along with all dividend income, in order to avoid losses in those years in which the market falls? There’s no right or wrong answer. But you need to be aware of the magnitude of the insurance premium.
The chart above plots the calendar-year price-only returns of the S&P 500 since 1928. The red line shows what your return would have been since then — 3.7% annualized — if you were flat in years in which the index fell, and earned 30% of the index’s increase when it rose. That 3.7% annualized return is a lot less than the 10.0% annualized total return the stock market has produced over the past nine-plus decades.
I’m not suggesting that FIAs are never appropriate in certain circumstances. In an interview, Hyers told me that there are many different FIAs to choose, and some that are benchmarked to indexes other than the S&P 500 have higher participation rates than 30%. Indeed, he added in an email, “many of the [FIAs benchmarked to] proprietary indexes have… participation rates above 100%, so those are where larger gains are locked in.”
My point in discussing FIAs is instead to remind you that there is no free lunch. The more you want to insure against losses, the more upside potential you forfeit in the process. While it is possible to insure against a black swan event, such insurance won’t protect you from all losses.
Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks invest/ment newsletters that pay a flat fee to be audited. He can be reached at mark@hulbertratings.com
“We are starting to see after that Consumer Price Index [CPI] print, really really extreme tails [played in markets],” RBC Equity Derivatives Strategist Amy Wu Silverman said. “We’re talking 100-to-1 market down another leg, 10% to 15% start to be played, which was not the case a month ago. And I think you’re going to start to see more of that, because really: What do you do in this market? You either derisk, degross, or you have to place some sort of bet to protect yourself when potentially CPI surprises even more.”
In turn, economists now expect the Federal Reserve to raise interest rates by 50 basis points at its policy meeting this week and signal further aggressive hikes to curb inflation into the end of the year.
By afternoon trading on Monday, markets were back to exhibiting violent swings as investors re-calibrate their growth outlooks.
Surfer Cole Clisby falls while taking part in his surf P.E. class for his high school in Cardiff, California February 12, 2015. REUTERS/Mike Blake
The Dow Jones Industrial Average fell more than 600 points, while the S&P 500, Nasdaq Composite and Russell 2000 were all deeply in the red. The VIX Index — a measure of market volatility known as Wall Streets fear gauge — has gained 10 point since the middle of last week.
Wu Silverman suggests getting creative with one’s trades in this type of rocky environment.
“One thing we have recommended specifically is to look at put spreads,” Wu Silverman says, adding that a potential port strike in July is intriguing as that would likely fuel more bad inflation readings.
(Bloomberg) — Wall Street traders are enduring fresh equity-market fireworks Friday after another week of global turbulence.
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Stock transactions spiked at the open as the expiry of stock and index options collided with that of index futures in a quarterly event known as triple witching. In the first 15 minutes of trading as the benchmark slipped 0.2%, volume on S&P 500 Index was more than double the average for that time of day over the past 30 sessions.
Roughly $3.5 trillion of single-stock and index-level options were estimated to expire Friday, according to Goldman Sachs Group Inc. At the same time, more near-the-money options were expected to mature than at any time since 2019.
And once again, this triple witching is coinciding with a rebalancing of benchmark indexes including the S&P 500 — a combination that tends to spark single-day volumes that rank among the highest of the year. According to an estimate from Howard Silverblatt, senior index analyst at S&P Dow Jones Indices, the rebalance in the index alone could spur $33 billion of stock trades.
Friday’s session landed just as the S&P 500 regained its footing with a three-day jump, buoyed by the Federal Reserve’s optimism the economy can withstand rate hikes and China’s promise to bolster its financial markets. But in the telling of derivatives pros, the recent rally was fueled by dealers covering short positions to balance exposures while demand for stock hedges was elevated.
Now as many contracts expire, the key question is whether investors will rebuild their holdings of protective puts amid growth concerns and the war in Ukraine — or will they chase the market rebound with call contracts.
“I’ve never seen an environment where you’ve had so many potential overhangs in the market that can not be controlled,” said David Wagner, a portfolio manager at Aptus Capital Advisors. “We’ll see if people can see to redeploy their puts.”
The S&P 500 climbed almost 6% over previous three sessions in the best rally since 2020, as the likes of Marko Kolanovic at JPMorgan Chase & Co. urged investors to go all-in.
Exploding derivatives volume has been a fixture of the post-pandemic market — whipsawing underlying stocks in both directions, again and again. To strategists including Charlie McElligott at Nomura Holdings, the recent advance in the S&P 500 was again amplified by the hedging activity of market-makers.
It’s a complicated process, but it works roughly like this: When a dealer sells a put option, it’s essentially taking a bet on the underlying asset to go up. To offset this unwanted directional risk, the market-maker typically sells some of the asset to maintain a neutral position. When the put options expire or get exercised, it will reverse those hedging moves — potentially creating a tailwind for the asset.
Another factor involving dealers is their current “short gamma” or “short delta” position that requires them to go with prevailing market trends: Buy stocks when they go up and sell when they fall.
At the start of the week, their exposure on S&P 500 products sat at a level near the maximum “short gamma” relative to history, according to estimates by McElligott, a cross-asset strategist at Nomura. Three days later, that turned into “zero gamma.” Along the way, dealers were forced to buy back stocks and close their short positions.
With market sentiment weak and institutional-fund exposure to equities near mutliyear lows, caution in the derivatives market is everywhere. The 20-day average of the Cboe put-call ratio for equities, for example, hovers near a two-year high.
“We see a general trend of continued risk aversion among investors, and expectations that the stock market remains volatile,” said Steve Sears, president at Options Solutions. “There are so many major events that could change the market’s tempo that hedging and patient fortitude appears to be the message from the options market.”
Options either far out of money or in the money receive less attention on Wall Street around expiration dates. Now with an unusually large number of S&P 500 contracts sitting close to the spot price this time round, trading activity on Friday looked set to be more frenetic than usual, according to Goldman strategist Rocky Fishman.
“The most interesting is options that are near the money, since as we approach expiration, there’s uncertainty about whether or not they end up in the money,” he said. “That uncertainty can lead investors to actively trade around those positions.”
