As US stocks rally on expectations of a deceleration in the spread of Covid-19, our models are … [+]
Our Market Take
After today’s rally in markets, we would use these “rally days” to find portfolio defense for portfolios in case the market faces future disappointments in the future. Continue to see iShares iBoxx High Yield Corporate Bond ETF (HYG) as a better hedge for equity risk than SPDR S&P 500 ETF Trust (SPY), iShares Russell 2000 ETF (IWM), or Invesco QQQ Trust Series 1 (QQQ). iShares 20+ Year Treasury Bond ETF (TLT) range trading between $145 and $170 looks productive until economic data clarifies. Invesco CurrencyShares Japanese Yen Trust (FXY) looks to be best multi-asset hedge to Dollar and Covid-19 disappointment risk. Be wary of outperformance of iShares Silver Trust (SLV) against SPDR Gold Shares (GLD). Stick with SPDR Gold Shares (GLD) and VanEck Vectors Gold Miners ETF (GDX). For income iShares National Muni Bond ETF (MUB) looks to be most favored by our Covariance models. Equities could continue to rise on the more sanguine Covid-19 data but it is doubtful the full economic impacts have been properly understood.
US stocks are rallying on a belief that Covid-19 cases and deaths are decelerating. While it is true that this wave may be receding in the very near future there are still many epidemiological and economic uncertainties. But in a world where the VIX still prints at over 40 for the past month despite historic promised levels of fiscal and monetary support, it’s easy to understand why bi-polar market behavior reigns. Bonds are weakening but SPDR Gold Shares (GLD) is up, as a result we don’t see a cleark “risk message” being sent to investors.
Throughout this note, we discuss the following ETFs:
- SPDR S&P 500 ETF Trust (SPY)
- iShares Russell 2000 ETF (IWM)
- Invesco QQQ Trust Series 1 (QQQ)
- Technology Sector Select ETF (XLK)
- iShares iBoxx High Yield Corporate Bond ETF (HYG)
- iShares 20+ Year Treasury Bond ETF (TLT)
- Invesco CurrencyShares Japanese Yen Trust (FXY)
- iShares Transportation Average ETF(IYT)
- S&P Transportation ETF (XTN)
- SPDR Gold Shares (GLD)
- VanEck Vectors Gold Miners ETF (GDX)
- Energy Select Sector SPDR (XLE)
- SPDR S&P Oil & Gas Exploration & Production (XOP)
- iShares Silver Trust (SLV)
- iShares National Muni Bond ETF (MUB)
Top Plays in Credit
- HYG correlations to the S&P 500 are still running at about 86% with volatility in the 70% of S&P 500 levels: there is still room for the unwinding of credit risk to hurt high yield credit valuations. Remember high yield credit maturities usually lie in the 3-5 year range. Even if the Covid-19 economic damage lasts only 3 quarters, that’s a big part of the expected lifetime of the issues. Large Cap equities are glorified perpetuity instruments – meaning they have a much longer term to make up for lost ground. Under Black Scholes optionality, stocks should have much better value than more limited high yield credits. Hedge HYG with put strategies. Correlations continue to remain expanded and FXY still showing greater negative correlation to S&P 500 than even TLT.
- MUB (municipals ETF) looks like a solid investment for yield seeking investors on a total return basis. It’s not clear any of us will ever pay taxes again (tongue in cheek) so we’re not giving tax advice.
Tech Stocks Overvalued
• XLK is also showing a near historic correlation (+86%) to S&P 500 which is concerning as XLK’s implied volatility is over 30% higher than S&P 500’s implied volatility. Tech can be cyclical and any thought tech orders won’t be affected by the lack of paychecks and revenues, valuations are not realistic. With XLK 2m Skew, 1.36 std devs over its trailing mean, the options market is communicating concern to the downside.
Transportation Stocks Options Cheap
• XTN (transports) are running at high levels as well around 85% but the difference we see here is that the fundamentals of food security, deregulation, and cheap gas could allow many of these truckers to outperform other sectors. In this case the lower correlation to the S&P 500 could drop further making this sector interesting as a positive play. As there are no options on XTN, we like the CH Robinson Worldwide CHRW August risk reversals as solid plays on this sector). An alternative can also be IYT – similar to CH Robinson Worldwide, 2m Skew leans bearish. Risk reversals are in play if one wants to be aggressive. IYT options could also serve as a bullish vehicle but its greater exposure to railroads could make it slightly less of a concentrated trucker play.
Commodities Look Attractive
• SLV valuations appears to be supported by investors looking to buy an industrial recovery — the rally is premature. With better implied volatility and skew technical, GLD and GDX are better Dollar weakening plays from here. GLD 2m IV is off its most elevated levels (95th percentile) and with Skew slightly bearish, calls or call spreads look attractive.
• XLE and majors longs facing headwinds might be a buying opportunity. Despite growing confidence that oil producers will come together to curb supply, 2m Skew in USO remains stubbornly bearish (1.77 std devs over trailing mean). The same can be said for other oil-related ETFs: 2m Skew in XLE (Energy) is 2.13 std devs over its trialing mean (though off most extreme levels); XOP (Oil Producers) 2.55 std devs over trailing mean. The OPEC+ meeting is now expected to take place on Thursday, April 9th