Wall Street Offloads Crash Insurance As Fear Fades Across Assets

(Bloomberg) -- After weeks of drama, peace is breaking out everywhere you look across Wall Street.

Even as traders have been forced to roll back their dovish monetary bets in epic fashion this year, demand to barricade portfolios from an oncoming market storm has vanished. 

Appetite to hedge against a stock crash has hit a nine-year low by one measure with fear fading across the options landscape big and small, from equity to fixed income. All told, a Bank of America Corp. indicator of cross-asset stress is flashing benign signals. 

It’s a sentiment shift of sorts from the higher-for-longer monetary anxiety last month that spurred investors to bid up downside protection as equity volatility rose. 

Thank a healthy earnings season and the enduring US economic expansion. Put another way, investors don’t see the data-dependent Federal Reserve as their enemy right now — despite their skepticism that risky assets will post big gains before the year is out.

To Amy Wu Silverman at RBC Capital Markets, it’s all a little suspect – not least given the fact that the world’s most important central bank is in no rush to cut rates, among other reasons that warrant vigilance.

“At this point, I think we are getting a bit complacent,” said Silverman, head of derivatives strategy at RBC. “That exuberance has been sucked out of the right tail is telling and a noticeable shift.”

The serenity on Wall Street comes as the S&P 500 scored its third straight weekly advance, notching a near 1.9% gain. Treasuries climbed for a second week as credit markets advanced. The VVIX Index — which measures expected swings in the equity-volatility index itself — hit its lowest level since 2015, a sign that investor appetite to hedge against a big selloff has waned.

Next to April’s tempests, the restoration of calm suggests America’s great bull market has life. Stress started seeping out of markets right after Fed Chair Jerome Powell last week played down talk of a rate increase and eased further, as corporate earnings arrived with only a few major blemishes. The majority of S&P 500 companies have reported results and so far 79% have beaten analyst expectations, according to data compiled by Bloomberg Intelligence.

Still, removing downside protection has famously burned Wall Street bulls in the past. And economic data release after release continues to leave pros puzzled on the direction of the business cycle. 

“The first hotter-than-expected inflation reading will bring the hedging back quickly,” said Michael O’Rourke, chief market strategist at JonesTrading. 

Next week economists expect a 0.4% monthly increase in the CPI index for April, matching the rise in the previous month. 

Wall Street eminences gathering at the annual Milken Institute Global Conference debated the case for caution in the coming months. Citigroup Inc. chief Jane Fraser said equity valuations have potential to go higher — if rates come down. Citadel founder Ken Griffin said the first cut could come in December. Meanwhile private credit managers signaled fears that corporate America will struggle with their debt loads in the event central banks keep interest rates higher for longer. 

Meanwhile the lack of caution right now is itself a contrarian indicator for many market watchers. While there are technical factors suppressing volatility — including the rise of zero-day options and covered-call ETFs — the drop in the VIX is noticeable. The magnitude of the decline in the past 20 days has historically been a signal to sell stocks, according to analysis by Joe Kalish, chief global macro strategist at Ned Davis Research. 

For Mike Zigmont, head of trading and research at Harvest Volatility Management, investors should therefore pay attention when stress levels across assets drop this low.

“A lower level of perceived risk also does expose the markets to more of a reaction to a shock,” Zigmont said. “The key — which is easier said than done — is to identify when the market around you is excessively fearful/content and to go the other way, in reasonable size.”

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