(Bloomberg) -- Calm has been restored to Wall Street as US stocks resumed their climb this week but Deutsche Bank AG says investors still need to gird their portfolios against future wild asset swings.
“We expect volatility to stay at higher levels due to seasonality and change in markets which are no longer priced to perfection,” said Christian Nolting, Deutsche Bank’s global chief investment officer. Expectations have been reset after the once unstoppable equities rally stumbled on a weak jobs report and “good news is now good news and bad news is bad news.”
At the first glance, the market seems to have stabilized after last week’s gyrations as speculation grows that the Federal Reserve will be able to perform a widely anticipated interest-rate cut in September and earnings growth in the US finally extends beyond the biggest technology companies.
The S&P 500 hovered around 5,535 Thursday, erasing last week’s losses. Wall Street’s fear barometer, the Cboe Volatility Index — better known as the VIX — has eased after spiking to a level not seen since the heyday of the Covid-19 pandemic. But investors remain cautious as commodity market is flashing some warning signs amid rising geopolitical tensions.
Oil resumed a climb, jumping around 2% Thursday, as traders fretted over a potential Iranian response to last month’s assassination of a Hamas leader in Tehran.
“Escalation in geopolitical risks could lead to further spikes in volatility,” Nolting said in an interview. “We have dedicated strategies with risk-return engineering where we constantly hedge our equity exposure.”
Nolting recommends tail-risk hedging — a strategy that implies buying out-of-the-money put options. The strategy of insuring against severe market shocks saw a resurgence last week as the cost to protect against such a selloff surged.
War jitters come at a time when investors have become increasingly sensitive to economic signs of a slowdown, fueling fears that the US Federal Reserve is waiting too long for interest rate cuts.
“The biggest tail risk is always the one investors don’t prepare for,” Nolting added. “In addition to geopolitical risks, we would certainly look at the energy markets, the deteriorating fiscal situation of many countries and the potential bond market implications. Macro risks like inflation and growth risks also remain on our radar.”
Bloomberg Intelligence’s economic regime model also suggests more volatility lies in store for stocks in the coming months. The data imply “weak but not recessionary economic activity,” according to a team led by Gina Martin Adams, BI’s chief equity strategist.
Nolting expects the US economy to slow down this year — without falling into a recession — before re-accelerating in 2025. Once the Federal Reserve starts cutting interest rates, small and mid-size companies should start gaining, he said.
“Our current strategy is to close potential equity underweights by rebalancing the portfolios according to a market-cap barbell strategy. We stay invested in megacap stocks and add smallcaps.”
On a sector level, he prefers consumer discretionary versus consumer staples and favors price-makers — companies with strong brands — versus price-takers. He also sees industrials as a good way to play the US economic growth in 2025.
©2024 Bloomberg L.P.