A Delta Variant Hedge?
Teucrium | July 27, 2021
A Delta Variant Hedge?
Diversification When It Matters Most
Jake Hanley, Managing Director/Portfolio Manager July 19, 2021
Between February and March 2020 with COVID-19 spreading across the globe, the S&P 500 plummeted 33.79%. It took approximately 4 weeks for the stock market to give back nearly 3 ½ years’ of gains.[1] Compare that to the last correction in 2018 when it took more than 3 months for the S&P to drop 19.36% from peak to trough.
The speed of the selloff rattled global financial markets and undoubtedly left many investors reeling.
New Highs and New Concerns
After bottoming on March 23rd 2020, the stock market made a “V” shaped recovery and has continued to put in a series of new “all-time highs” with the most recent one recorded on July 12th. However, since then, and in only 5 trading sessions, the market has fallen nearly 3% and volatility has exploded 31% higher.[2] Market commentators are blaming the recent selling on concerns surrounding the spread of the Delta Variant.
To be certain, some tactical investors welcome increased volatility. Large price moves in either direction create opportunities for short-term traders to profit. Additionally, a nimble trader may be comfortable taking large positions in only a few holdings. For this type of short-term trader, risk management consists largely of being able to get in and out of positions quickly.
However, most investors are not short-term traders, but rather long-term investors. Instead of relying on speed to help manage risks, long-term investors tend to rely on the principles of portfolio diversification as the basis for managing risk. Investors with whom we’ve spoken are looking to alternative investments, such as commodities, to broaden their portfolio diversification.
Hear Delta : Think Diversification
Given the recent spike in volatility and talk of increased spread of the Delta Variant, investors may do well to review their portfolio allocations. It may be particularly important to take note of investment correlations and review how different asset classes have behaved in previous stock market downturns.
When constructing a diversified portfolio, an investor is hoping to incorporate different holdings that zig when others zag. For example, consider that during the COVID sell-off (Feb. 2020 – March 2020 as referenced above) the GSCI Grains Index outperformed the S&P 500 Total Return Index by more than 29%. In fact, the GSCI Grains Index has outperformed US stocks in 10 out of the last 11 stock market downturns of 10% or more (see chart below). This, we believe, is an example of the potential benefits of diversification when it matters most.
Chart #1
Bloomberg – Daily prices; Yardeni Research – Dates of corrections and bear markets. For the entire period 1/1/1999 – 03/31/2020 the S&P 500 index had an annualized performance of 5.55% and the S&P GSCI Grain Index had an annualized performance of 2.62%. Performance data quoted represents past performance. Past performance does not guarantee future results.
Index performance is not illustrative of fund performance. One cannot invest directly in an index.
S&P GSCI Grains Index – serves as a measure for the investment performance of the grains commodities markets.
S&P 500 Total Return Index- serves as a measure for the performance of the U.S. equity market.
The relative outperformance during stock market corrections may be expected given that grains historically have extremely low correlations with stocks (see chart 3). Of course, historical performance does not guarantee future results. Still, consider that the fundamental factors impacting grain prices are largely different from those impacting stock prices.
Grain Market Fundamentals
Grains are primarily consumed as food; be it food for humans or food for livestock (i.e. animals that humans eat). Additionally, grains have many industrial uses. For example, the number one use for corn in the US is to produce ethanol that is blended with gasoline. The chart below illustrates the various uses for corn.
Chart #2
Iowa State University Center for Crop Research http://www.ccur.iastate.edu/education/cornposter.pdf
USDA https://www.ers.usda.gov/webdocs/publications/91013/fds-18l.pdf?v=4433.8
National Corn Gowers Association http://www.worldofcorn.com/#/
As the global human population steadily increases so too does the demand for grains. Yet, production does not always keep up, and there are times when supplies decrease while demand is increasing. This puts upward pressure on prices. See our note “The Golden Grain Cycle” for a more complete review of this process.[3]
Historically unfavorable weather conditions, such as droughts, have been the chief culprit limiting crop production. Weather, of course, does not care about stock valuations, P/E ratios, the Fed Funds Rate, etc. Hence, the fundamentals impacting grain prices are largely independent of the factors impacting stock prices.
Chart #3
This is for illustrative purposes only and not indicative of any investment. Past performance does not guarantee future results.
Analysis and corresponding graphics were prepared by Teucrium Trading, LLC, using Bloomberg Financial L.P., January 1, 2021
Note: Commodities values are from futures (generic first) spot continuation charts. See Appendices for more details on Commodities used in this comparison.
S&P 500 Index taken from Bloomberg: SPX Index – An investment cannot be made directly in an index.
Portfolio Diversification That Grows
Given the historical low correlations to stocks and the history of outperformance in down markets, long-term investors might do well to consider a strategic allocation to agricultural commodities.
We designed our ETFs to be the easiest way to access grain commodities through a brokerage account. For long-term investors concerned about future potential stock market corrections, a review of your current holdings may be prudent. Note that options are available on our ETFs. Please speak with your broker and/or financial advisor for more information.
[1] Measured by the S&P 500 Total Return Index
[2] Stocks performance measured by the S&P500 Total Return Index. Volatility is measured by the Volatility Index (aka VIX). Performance data as of 07/19/2021
[3] Available on our website https://teucrium.com/news-insights/294