The Federal Reserve continues to hike rates, but the 10-year yield remains stubbornly below 3 percent, the S&P 500 in July had its best month in two years, and volatility has come down significantly since the Spring. It's not quite the contours of a market in the midst of monetary-policy tightening.
But Paul Britton of Capstone Investment Advisors says that's going to change in the second half of the year. That's when he thinks rate hikes will "come to roost around balance sheets, trying to determine and factor in a real, extraordinary move in interest rates."
"I struggle to believe that that's not going to catch out certain operators that haven't turned out their balance sheet, that haven't turned out the debt," said Britton in an interview for the Delivering Alpha Newsletter. "I think that you'll see some surprises and that's what we're getting ready for."
Britton thinks "Phase Two" could involve a different part of the credit cycle, involving a slew of negative headlines that will "cause the investor to question whether there's contagion within the system." However, he doesn't believe we'll see a "remarkable uptick" in the amount of bankruptcies and defaults.
Still, Britton, whose firm focuses on derivatives linked to volatility, says he isn't counting on the Fed to pivot and intervene as quickly and at the size and scale that the market is hoping for.
"If we do get an event and we do get a catalyst, then the level of volatility that you're going to be exposed to is just simply going to be higher, because that put – an intervention – is going to be further away," he said.
In light of the rocky future that Britton is painting, how should investors be positioning?
He says he's looking at ways to build in downside protection through options strategies and volatility strategies. But for those without access to more-exotic positioning, Britton recommends pursuing minimum volatility securities or more defensive stocks.
"The most important thing is to do the work to be able to ensure that when you're running your portfolio through different types of cycles and scenarios, that you're comfortable with the end result," he said.
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