Zhitong Financial APP learned that for the conservative school of Wall Street, this seems inevitable. When bonds begin to offer decent yields, people lose interest in venture capital, which prevailed during the period of zero interest rates.
This is not the case. While Treasuries have played a role, such as the two-year Treasury yield near 5% for most of April, the expected speculative retreat has not materialized. Looking at the past five days, Bitcoin has risen by 9%, stocks and commodities have also risen sharply, and some social media posts have made Game Station (GME. US) and AMC (AMC. US) has re-enacted the 2021 frenzy.
While risk-free rates are fairly healthy, they have little dampening demand for other forms of high-yield investments, from exchange-traded funds (ETFs) that sell options to structured products. ETFs that use derivatives to boost cash returns attracted $13 billion in new money in the first four months of the year, according to data compiled by Global X ETFs.
All of this is at odds with the theories that prevailed during the pre-pandemic zero interest rate policy (ZIRP) period. These theories argue that the enthusiasm for speculative assets and complex investment products is a direct result of investors not being able to find alternatives in safer markets.
Edward Park, chief asset manager at Evelyn Partners, a London-based wealth manager, said: "Whether it's caused by fiscal stimulus or because interest rates have been low for a long time, there's still a lot of money flowing in the market. Phenomena such as GameStations may just be a symptom of this condition and not anything else. ”
The resilience of the speculative spirit continues to surprise markets. Just this week, former President Donald Trump's chief economic adviser, Gary Cohn, argued that the extension of high interest rates has prevented investors from taking risks. However, the main threat now is not overly pessimistic, but rather that everyone from hedge funds to retail investors is so bullish on the market that it could collapse due to its own excessive optimism. An April report by Morgan Stanley's trading division noted that the increased concentration of the same stock, combined with improved investor positioning, meant that if something went wrong, the consequences could be felt quickly.
The team, which included Christopher Metli and Amanda Levenberg, wrote: "These dynamics increase market vulnerabilities, and risks are intertwined – the high overlap of hedge fund longs with the S&P 500 suggests that any hedge fund de-risking could drag down the market as a whole, while any macro shocks are more likely to drag down hedge fund portfolios." ”
All major assets from equities to bonds to commodities rose this week for the best market-wide rally of 2024, as data on weak retail sales and cooling inflation reinforced optimism that the Federal Reserve was about to reverse its tightening. The S&P 500 rose for the fourth straight week, its longest since February, while the Dow Jones Industrial Average topped 40,000 for the first time.
One sign of increased OTC market participation is a surge in volume on OTC venues (where computer traders typically match the broker's order flow) to a record 52% of the total market volume.
"OTC traders are banding together again in 2024," Scott Rubner, managing director at Goldman Sachs Group Inc., wrote in a note Friday. "It's become something I have to monitor every day now," he added. "I'll be checking the message board this weekend as holders are looking for a new gamified name for next week."
While the debate over the extent of US savings depletion continues, wallets remain loose among the predominantly wealthy investor class. Almost $12 billion flowed into equity funds in the week to Wednesday, while funds focused on high-yield bonds attracted money for the second week in a row, according to EPFR Global data compiled by Bank of America Corp.
In the eyes of the bulls, financial conditions have not yet been tightened – a legacy of years of quantitative easing. Of course, the U.S. economy remains stable, which also supports the case for venture capital.
The theory that explains the persistence of risk appetite is that the so-called "Fed umbrella" has been in the market for so long that people are still accustomed to thinking that the central bank is ready to act as a savior for the market.
Mohit Kumar, a strategist at Jefferies Financial Group, wrote in a note on Friday: "As long as the option of a rate cut exists, we would argue that the 'Fed umbrella' is still on the table, which should continue to support risk assets." ”
In the Bank of America survey released this week, fund managers showed the highest allocation to equities since January 2022, just before the Federal Reserve began raising interest rates. Eight out of ten managers expect a rate cut in the second half of the year – and no recession.
Even in the world of yield products, demand is surging in the riskier segments, even though US Treasury bills (which are almost equivalent to cash in terms of risk allocation) offer yields of more than 5%.
Attracted by returns that in some cases are advertised as yields of more than 100% per annum, investors flock to ETFs that sell options. More than 20 new ETFs have been listed this year, and total assets have jumped to a record $81 billion, according to Global X. The Chicago Board Options Exchange Global Markets recently launched a margin reduction program to make it easier for traders to write index options contracts.
Despite the risk that dividends could be swallowed up by losses from options sold by traders to boost returns, these products are thriving.
Adam Phillips, portfolio manager at EP Wealth Advisors, said: "Many investors are attracted to these strategies because of their high yields and lower volatility, and of course, this income and stability comes at a price, and we've seen how these strategies are well below the broader market benchmark." ”
Meanwhile, U.S. structured product sales increased by 20% in 2023 to a record $132 billion and have already reached $61 billion in 2024, according to Structured Product Intelligence. Many of these complex notes – especially popular in Asia during periods of low interest rates – pay investors coupon by effectively selling equity volatility, potentially losing money when the underlying security falls below a certain threshold.
As Cullen Roche, the fund's chief investment officer, explains, these products have been welcomed by financial advisers who have been looking for alternatives to bonds after witnessing the bond sell-off in recent years.
More than two years after the Fed began tightening policy, the question now is whether all of this will change as investors adjust to a world of high interest rates.
"In theory, monetary policy has its long-term and variable lag effects, and we'll see how true that is," Roche said. ”