Wall Street Dusts Off Trade-War Battle Plan Now All Bets Are Off

(Bloomberg) -- Build up hedges from Treasuries to high-octane options. Get out of carmakers. Resist credit and emerging markets.

Those are just some of the ways battle-ready investors are riding U.S.-China trade tensions as $2 trillion gets wiped off stocks -- halting the bubbling melt-up across risk assets along the way.

With Friday’s deadline on fresh tariffs looming, all bets are off as a Chinese delegation arrives in Washington on the heels of President Donald Trump’s fiery rhetoric. Some money managers are dusting off their safety playbook in earnest, with echoes of tumult in 2018.

“We tactically added to Treasuries on the back of trade wobbles,” said Mark Holman, chief executive officer of TwentyFour Asset Management in London. He’s “holding off credit” and sticking to less volatile, short-term debt.

Here are some tactics to consider for the brewing conflict:

Small World

The thinking goes that when trade tensions hit, U.S. small caps hold up while Chinese stocks wallow in pain -- and there’s a trade to front-run just that.

Pravit Chintawongvanich at Wells Fargo recommends using the two largest ETFs tracking those markets -- BlackRock Inc.’s China Large-Cap ETF, or FXI, and the Russell 2000 fund, or IWM. Selling protective puts on IWM while buying them on FXI can help investors weather brewing tensions in global commerce, according to the strategist.

Wall Street Dusts Off Trade-War Battle Plan Now All Bets Are Off

Junk Jitters

High-yield bonds are in the firing line should the latest jawboning over commerce assume a more insidious posture. Yet implied volatility tracking the biggest junk-bond ETF is decidedly low relative to the Cboe Volatility Index, or VIX, potentially making it a cheap hedge.

Macro Risk Advisors recommends buying put options on BlackRock’s benchmark product, with the investing strategy reaping fruit if the price of the ETF dips or price swings break out.

Wall Street Dusts Off Trade-War Battle Plan Now All Bets Are Off

Bonds Are Best

Don’t fret low yields -- longer-dated bonds can make money for cash-rich investors in dashes to safety. Lately, they’ve tended to rally a lot more when risk appetite nose-dives, and they have a canny propensity to stay relatively firm when equities advance.

“For now, our worst-case scenario is a modest correction in global risk assets rather than a full-fledged meltdown,” according to Gaurav Saroliya, head of macro strategy at Oxford Economics. “Even so, the case for maintaining portfolio hedges remains.”

The firm is upgrading core government bonds, downgrading cash and trimming overweights on all risky asset classes.

Over at TwentyFour Asset, Holman thinks market bets on U.S. interest-rate cuts are overdone, but tensions in global commerce are spurring a more-bullish posture at the firm.

“We initially thought UST had the chance to creep higher in yield so we sold some 10-year notes,” he said. “But after the U.S.-China talks wobble we bought them back.”

U.S. Exceptionalism

It’s too early to go all-in on America First trades, but here’s a top-down reminder about the defensive play from Alain Bokobza, head of global asset allocation at Societe Generale SA.

“The protection for now is back to the U.S.,” he said in an interview with Bloomberg TV Wednesday. “These are periods where you go back into U.S., you go back into the dollar, you go back into U.S. equities, which are outperforming the rest. They are falling, but in a lower manner than what happens in China or Japan.”

Wall Street Dusts Off Trade-War Battle Plan Now All Bets Are Off

Pump the Brakes

Don’t forget: Europe is acutely in the firing line if the hawkish stance from the White House endures. A favorite Trump target, carmakers in the region, look especially vulnerable right now. The Stoxx 600 Automobiles & Parts Index has outperformed the broader benchmark by around 3 percentage points this year.

As the gauge of carmakers trades at about 505 euros ($566), Citigroup Inc. suggests a put spread where the investor simultaneously buys protective options at a strike price of 490 euros while selling contracts with a 460 strike. The structure helps offset the cost of the bearish bet and limits losses. The trade makes sense for investors who expect the gauge to fall, but not too far.

“With the Trump administration in a hawkish mood, we believe SXAP remains vulnerable,” Citi strategists wrote in a note.

Wall Street Dusts Off Trade-War Battle Plan Now All Bets Are Off

Submerging Emerging

With China taking up more than a quarter of the iShares MSCI Emerging Markets ETF, Evercore recently recommended a put strategy on the fund to hedge against event risk like Trump’s broadsides on Twitter. The trade gains with limited downside risk as long as the price of the fund drops, though returns are capped.

While the firm reckons an agreement can be reached -- curbing the allure of the investing style -- it says the $34 billion ETF remains a hedge-worthy vehicle for trade bears.

New World

Goldman Sachs Group Inc. gets the final word.

Trading last year “suggests services-providing stocks will outperform goods-producing stocks as long as the trade dispute continues,” strategist at the bank led by David Kostin wrote in a note.

Service providers he cites include Microsoft Corp., Amazon.com Inc. and Berkshire Hathaway Inc. Among goods producers: Apple Inc., Johnson & Johnson and Exxon Mobil Corp.

©2019 Bloomberg L.P.