Stocks dropped in early trading as investors prepare to wrap up the worst first half of the year in decades. The first six months of 2022 have been wrought with pain for the major indexes. Moving into the second half of the year many are wondering – are we turning the page on an ugly chapter, or is it time for a wake up call?
Looming recession fears and deteriorating consumer sentiment took the wind out of the sails of early week gains when The Conference Board reported that US consumer confidence dropped to 98.7 in June to the lowest level in more than a year as inflation continues to dampen the spirit of the American consumer. The firm also reported that the expectations index (which reflects consumers’ six-month outlook) plummeted to its lowest level in more than a decade, indicating that Americans have grown more pessimistic about the economy, income and labor markets.
“Consumers’ grimmer outlook was driven by increasing concerns about inflation, in particular rising gas and food prices,” Lynn Franco, senior director of economic indicators at The Conference Board, said in a statement. “Expectations have now fallen well below a reading of 80, suggesting weaker growth in the second half of 2022 as well as growing risk of recession by year end.”
While all attention is focused on inflation right now, recession cycles come with a more substantial risk for deflation. Today we’re focusing on an investment that provides access to a part of the market (until recently, reserved exclusively for large institutions) that can help hedge a portfolio against the effects of deflation and the compression of the yield curve.
Extreme over-indebtedness has been dramatically worsened by multiple rounds of fiscal stimulus in response to the global pandemic. Deflation may be the most challenging economic environment for investors.
KraneShares Quadratic Deflation ETF (BNDD) is a fixed income ETF that seeks to benefit from lower growth, deflation, lower or negative long-term interest rates, and/or a reduction in the spread between shorter and longer term interest rates by investing in US Treasuries and options.
The BNDD portfolio is composed primarily of long dated US treasury bonds. In addition to bonds, the portfolio includes long-only options on the shape of the US interest rate curve. As interest rates decline, the bonds should appreciate in price. The options provide exposure to spread between interest rates at different points in time. As the curve flattens because of lower inflation expectations and/or deflation, the price of the options tends to increase.
BNDD provides a unique access point to OTC fixed income options market which is typically not available to investors directly. The fund has the potential for enhanced returns in periods of lower growth while options downside is limited to the market value of the options. This strategy can serve as a bond enhancement strategy and works well as a complement to other diversifying investments. Since its inception less than one year ago, BNDD has essentially matched the performance of the S&P 500 with a fraction of the risk.
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