Risk-On Is Back as Rally-Hungry Bulls Set Aside Trade Fears

(Bloomberg) -- The fiercest rally in U.S. stocks and corporate bonds since January showed bullish traders are ready to run wild.

By some measures, Tuesday was the most risk-on day this year following a painful month of losses spurred by U.S. trade aggression and concern the Federal Reserve wasn’t willing to support the economy. The optimistic wagers could be seen across asset classes, becoming the dominate force in everything from tech stocks to junk bonds to volatility markets.

The extension of the rally Wednesday after the sudden swing to the upside that popped up the day before shows it wouldn’t take much for bullish sentiment to take hold of the markets. The S&P 500 Index was less than 5% away from its all-time high on the heels of its 2.8% advance over the past two days, driven by supportive comments from Fed Chairman Jerome Powell and signs trade tensions might dissipate.

U.S. equity exchange-traded funds showed the euphoria. The Invesco S&P 500 High Beta ETF, a fund that practically screams “risk,” posted its biggest daily outperformance this year over the much-tamer Invesco S&P 500 Low Volatility ETF. On a similar note, the AGRiQ U.S. Market Neutral Anti-Beta Fund (which goes long the safest stocks and shorts their more volatile peers) suffered its worst loss since November, falling 2%.

“We are tactically preparing clients to shed low-vol exposure (or reduce risk aversion) over the coming weeks and particularly into further strength,’’ said Christopher Harvey, the head of equity strategy at Wells Fargo Securities.

The options market showed little fear of what comes next. CBOE Global Market’s intraday composite put/call ratio -- updated every 30 minutes -- shows investors favoring bullish bets over cautionary insurance throughout the day. That marked the first time that’s happened since May 3, prior to President Donald Trump’s tweet that higher tariff rates on Chinese goods were imminent.

Maxwell Grinacoff, quantitative strategist at Macro Risk Advisors, sees further signs that investors are using the derivatives market to get exposure to a renewed rally.

“The flattening in skew is likely driven primarily by hedges getting monetized on the sell-off, but we have also observed the call wing get slightly bid as investors are potentially positioning for a snapback” later this month, he said. He noted that the spread between the implied volatility of three-month at-the-money versus upside options has narrowed in recent sessions. In general, the smaller this spread, the more calls are relatively bid.

“I feel like people want to be long this market, but need the headline,’’ he concluded.

For tech stocks -- at the center of the trade dispute between the U.S. and China -- investors seem to be betting that the worst of the storm has passed. The CBOE NDX Volatility Index, which gives a measure of one-month implied volatility for the Nasdaq 100, is trading below realized volatility over the past 20 sessions with the gap yesterday hitting the biggest since January. That’s effectively a wager on things getting better.

The appetite for risk wasn’t limited to equities, either. The 1% gain in HYG, the iShares iBoxx High Yield Corporate Bond ETF, propelled the fund to trade at a 0.4% premium to its net asset value -- the largest since April 10. As HYG is more liquid than the underlying junk bonds it holds, the appearance of this premium could be an early sign that chilly sentiment toward the asset class is quickly thawing.

--With assistance from Andrew Dunn.

To contact the reporter on this story: Luke Kawa in New York at lkawa@bloomberg.net

To contact the editors responsible for this story: Jeremy Herron at jherron8@bloomberg.net, Brendan Walsh, Randall Jensen

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