Throughout 2019, in anticipation of a potential increase in volatility, we have been balancing our pro-risk positions with countercyclical hedges. Now that volatility is here, our countercyclical positions are behaving as expected. Here are some we currently hold in our tactical asset allocation, and how they are faring:

* Holding Japanese yen exposure. The undervaluation of the Japanese yen, along with its tendency to appreciate when global risk aversion increases, makes the yen an attractive countercyclical position. As equities have fallen this week, the Japanese currency has appreciated by 0.9% versus the US dollar. Our portfolios have benefited as we do not currency hedge our exposure to Japanese equities.

* Put options on the S&P 500. The low volatility period at the beginning of 2019 was a good time to add downside protection, as we discussed in our April notes Plan, Protect, and Grow and Strategies for a low volatility environment. In our tactical asset allocation, we have held a put on the S&P 500 with a strike price of 2,700. As the S&P 500 has declined toward our strike price, and as volatility has risen, the value of our option has increased over the past week.

* Underweight Italian 2-year bonds. Weaker credits tend to suffer in periods of risk aversion, and our underweight in Italian 2-year government bonds versus euro investment grade credit has benefited from the risk-off shift and news on Italy’s deficit. The European Commission now expects Italy’s government budget deficit to reach 2.5% of GDP this year and 3.5% next year, breaching EU treaty limits. Italian Deputy Prime Minister Matteo Salvini responded that the government will press ahead, increasing the risk of conflict between the European and Italian governments. By combining pro-risk positions (in markets such as Japan and emerging markets) with countercyclical ones (like those listed above), investors can position for the upside while being relatively insulated in the event of market shocks.