While the events of the last week have resulted in a sharp flight out of stocks and a spike in short-term volatility, long-term volatility has barely budged. As a consequence, even credit spreads, though widening a little bit, have barely registered any possibility of a recession and credit defaults. In my view, this provides an unprecedented opportunity for investors to (1) Hedge their portfolios, (2) Prepare for recession remote as it may be, (3) Create the asymmetry that might result in long term opportunities via the generation of liquidity.
As I discussed in two pieces over the last couple of weeks, the market has been too complacent about the current events morphing into something bigger. We are seeing the path-dependency that emerges from large events driving forced reactions from participants. However, the collective mind-set still seems to suggest that investors are betting on a sharp pivot from either the administration or the Fed (to cut rates), or the hopes of trading partners negotiating down mutual tariff rates. This might still happen and would likely be a positive development for markets, but each day of delay is likely to create an acceleration in the selloff in the markets.
The full note on this important topic can be downloaded at this link: LTA Thinking – Long-Term Tail-Hedging Is Still Cheap