Investors hedge against sharp stock market correction – Financial Times

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Money last month poured into funds and securities that offer some protection against a sharp correction in the US stock market, the latest sign of cautious behaviour from both professional and retail investors in response to equities at record levels.

Preparation for the risk of upset comes as market activity slows for the summer and in advance of possible central bank action in September, when policymakers may announce plans to remove crisis-era monetary policy measures.

Nikolaos Panigirtzoglou, cross asset strategist for JPMorgan, said conversations with clients in recent weeks had been dominated by what may happen if the Federal Reserve and European Central Bank withdraw stimulus in the autumn.

He said: “Investors have already started reducing their net exposure to risky markets via hedges in order to protect themselves against a repeat of the August 2015 correction” — a month of turmoil prompted by fears for the Chinese economy.

Attempts to insure against market losses come as the S&P 500 index has risen more than 10 per cent so far in 2017, extending a rally for US stocks into an eighth year and pushing long-term valuation measures close to records.

In the four weeks to July 28, retail investors pushed $445m into exchange traded funds tied to the Vix, an index designed to represent the volatility of day-to-day movements in the S&P 500.

The value of the Vix, which in July hit its lowest intraday point since the 1990s, is expected to rise if markets become more volatile, and the high cost of Vix ETFs makes them speculative, short-term investment vehicles.

“Monetary policy tightening from the FOMC and ECB are the most likely catalysts for an uncertainty shock,” said Michael Underhill, chief investment officer at Capital Innovations.

However, Mr Underhill said central banks have a habit of “arriving late to parties,” so he was looking for buying opportunities in such market pullbacks.

He has been taking profits on the high-flying technology sector and may consider rotating into sectors that have underperformed tech, such as energy and materials companies.

Weekly fund flow reports suggest cash has continued to move into bond funds, which may reflect investors attempting to rebalance their portfolios in response to the rising value of stock holdings.

Fixed income mutual funds had attracted $355bn in the first five months of this year, putting the sector on course to beat 2016’s full-year inflows of $375bn, according to Morningstar.

Markets used by professional investors provide other indications of efforts to insure against instability. The ratio of option contracts that pay out when the Vix rises, versus those which pay out when it falls, is close to a record high, according to JPMorgan.

The ratio between outstanding puts and calls for options on the level of the S&P index is less extreme.

After months in which the day-to-day movements of stock markets have been unusually calm, Mr Panigirtzoglou said the option market behaviour may reflect greater demand for investors using hedging arrangements in anticipation of a spike in volatility, rather than typical market correction.

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