Your Move

October 5, 2023

Nilesh Jethwa
CEO of Marex Solutions

My ominous post from early August about the risks in the fixed income markets proved correct – but that’s not good news. It now seems we’re moving towards a stagflation environment for many Western countries, which could have profound implications on asset allocation.

But there are at least two bits of good news. First, recent data points to a “stagflation-light” environment. Meaning uncomfortably high headline inflation (commodities) and weakening growth, but not a major recession or unanchored inflation expectations. Second, stagflation can present many interesting investment opportunities – sitting tight and hoping for the best is probably not the best strategy.

I wanted to share some of the thematic ideas that have come up in my conversations with clients and our trading desk.

In short, they fall into the following buckets:

    • Navigating sectoral rotation
    • Market-neutral relative value plays
    • Gaining exposure to the commodity rally
    • Shortening bond duration
    • And exploring non-directional options strategies

In the equity space, for example, many investors are re-weighting their portfolios from growth stocks (especially tech) towards defensive sectors (utilities, healthcare, energy).

This makes sense.

Stagflation is associated with a decline in corporate profits from a weak economy, but also with elevated interest rates applying a greater discount to valuations.

Some are expressing these views via relative value plays like options structures on different indices. For example, long Russell 2000 (small caps) vs short Nasdaq, or the difference between the S&P 500 equal weighted vs. market cap weighted.

Source: Bloomberg

In commodities, investor interest has gone well beyond oil. There’s a lot of excitement around Uranium as a way to solve both the energy deficit and green transformation requirements, and investors are finding new ways to gain exposure to this theme.

More broadly, gold’s store of value properties could help it outperform abundant base metals like nickel in this environment, and even agricultural commodities, in a stagflation environment.

Source: Financial Times

In fixed income, the spirit is more defensive, with many investors looking to hedge their exposure to duration risk. The 2 to 10 year Treasury curve has steepened some 40 bps since my August piece, but remains very inverted.

I fear we’re not yet done with the adjustment and that markets may face more volatility ahead.

With uncertainty rising, non-directional options strategies and structured products are becoming popular again.

These are structures that protect against tail risks and profit from potential volatility spikes. For example, we’ve seen more demand for strangle and straddle options structures, or “twin-win” strategies, which can make money if markets rise or fall.

While the “new normal” for rates is nothing special from a historic perspective, the amount of debt, and the speed of change in the price of that debt are having implications which are yet to fully play out. We have not reached the end game.

CDD Disclaimer

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