At BNP Paribas’ 4th Quant Virtual Conference in May, panellists offered various perspectives on why, what and how to hedge with quantitative investments, particularly as the seemingly impervious bull market lurches forward.
Leading the event, Greg Boutle, US Head of Equity & Derivative Strategy at BNP Paribas, told participants there is still a case to be made for equities in the post-Covid recovery climate — it’s just a question of which type. For instance, the current “reflationary” trend is likely to provide ongoing support for value traders, noted Boutle.
“Value versus growth has been a key theme for the markets, particularly over the last six months or so, and we think that is going to continue to evolve going forward,” Boutle told moderator Olivia Frieser, the bank’s Global Head of Markets 360TM Strategy & Economics.
“It was only when rates began to tick up in the US that we saw growth move lower in absolute terms. More recently, the rotation into industrial cyclicals and commodities markets has been a driver for value plays. So looking ahead, being more selective in terms of equity allocation will certainly remain a priority.”
Value versus growth has been a key theme for the markets, particularly over the last six months or so, and we think that is going to continue to evolve going forward.
Greg Boutle, US Head of Equity Derivative Strategy
BNP Paribas
While current monetary policy has helped promote equity bullishness, that could change should the Fed become less accommodative. There is a possible silver lining to April’s much-lower-than-expected payroll numbers, said Boutle, “in that the Fed could potentially delay any tapering, particularly if there are signs that the payroll ‘miss’ was actually due to a supply constraint, rather than lack of demand.”
Still, at an average forward price-to-earnings ratio (P/E) of around 22 times earnings, stocks are indeed in nosebleed territory, similar, in fact, to the pre-selloff multiples of the late 1990s bull rally.
“We all know how the dot-com bubble ended, which makes it hard to see current pricing as anything other than a red flag,” said Boutle. Of course, one differentiator is that short yields were far more generous then (around 6%) compared to now (1.67% as of mid-May). Meanwhile, the main indicator of general market volatility, the VIX, has remained stubbornly elevated as well.
“As a result, simply buying outright tails or variance to hedge could be quite difficult during this time,” said Boutle.
Additionally, forward earnings could be impacted should a proposed US corporate-tax increase to help fund infrastructure development become law. “And if spreads between variance and volatility were to remain elevated, it will become more challenging to maintain convexity within an equity portfolio,” said Boutle.
Hence the importance of keenly understanding which hedging strategies are likely to be the most effective, given these types of scenarios. Boutle points to quantitative investment strategies and investable indices as a useful tool in that context. “If we think it’s a short-term shock rather than a full-blown recession, then we’d more likely look at hedging the body of the distribution rather than the tail, and would be more focused on growth rather than value issues,” said Boutle. “Whereas a recessionary shock would make value plays more vulnerable and would also involve hedging the tail of the distribution, which is a far more complex and expensive undertaking. So it’s a significant challenge that we hopefully do not have to deal with any time during the current year.”
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