DAILY STRATEGY: The Fed and/or 10yr yields will keep pushing rates to a place that accomplishes the goal of slowing economic growth and inflation. Our call is 10yr yields around current levels WILL deliver a mild slowdown (HERE). The RISK is the current level of 10yr yields doesn’t slow economic growth enough to respect the economic speed limit (~2% real GDP growth). We covered the equity implications of the modal path that the 10yr at current levels delivers the slowdown in yesterday’s Weekly (HERE) – in short, AI capex holding up as the rest of the economy slows favors the AI buildout names, EPS Momentum, Price Momentum, GARP, and companies that are less Cyclical but using AI to improve fundamentals, relative to non-AI Cyclicals (Retailers, Transports, Banks), debt risk, and small caps. Today, we focus on risk management around higher 10yr yields.
IF growth proves more resilient than we expect, 10yr yields will move higher as the Fed shifts to “doing what it takes” to lower inflation, accepting the higher recession probabilities that come with that stance. We don’t think this is the modal path, but the risk is emerging. A lower unemployment rate (below 4%) with still well above 2% Real GDP growth and above 3% core PCE inflation would increase those odds.
One of our preferred methods for positioning for lower probability outcomes is through options where the vol setup is favorable. Jeff Jacobson, 22V Derivatives specialist, covered his favorite hedges against higher Treasury yields HERE. Jeff thinks that the options on the S&P 500 or NASDQ are not the best vehicle to hedge against higher rates because of Tech’s resilience to higher rates and large index weight. We agree given AI activity will NOT be the source of weakness. Financials (XLF) puts have worked well, but now Jeff thinks the risk reward in the options has deteriorated. The vol setup is better for short EFA (Europe) and short GDX (Gold), both of which come under pressure from a stronger Dollar (a likely outcome from higher US yields).
Trade:
Buy GDX November 20th 90 puts for ~ $4.40 (GDX 92.87 Fri close ref)
Trade:
Buy EFA November 20th 104/97 put spread for ~ $1.20 (EFA 105.56 Fri closing ref)
More details from Jeff in the full report below.
OUR PROCESS: The first note of the week focuses on our overall process. The below graphic details the medium to longer-term views (6+ months) for equity internals based on the current economic backdrop, the modal outcome for that backdrop, and the sensitivities of the backdrop. When we mark to market our views based on new market and macro data, and talk about short-term risk management, it is always relative to what our background process implies.
From Jeff…
GDX Trade Details:
- Buying the November puts that start 3% below spot
- We saw the miners outperform the commodity when gold rallied sharply in July and August (should see some further pullback in the relative spread should gold weaken more)
- GDX 2-month 40-delta put vol at the 2026 lows (why I favor buying the puts outright)
- Most of the top-weighted names in GDX will report at the end of October/early November (why I favor the November puts)
- Puts can be bought to hedge a long gold position, or as an outright bearish bet given strengthening US$ as well as GDX/GLD spread back near the highs
EFA Trade Details:
- Buying the 7-point wide November put spread that starts ~ 1.5% below spot
- We continue to see European stocks underperform their US counterparts, especially as the Euro weakens against the US$
- EFA/SPY relative spread made a new low, and EFA trades “rich” to where EUR/USD currently trades
- Put spread hedge offers a nearly 5x to 1 max payoff on the limited-risk hedge (bearish bet)
