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10 02 2015 | by Victor Xing | Capital Markets

What are the best investments during a severe stock market downturn?

7 year U.S. Treasuries would be a good choice if an investor holds a view that there will be a severe stock market downturn (sell-off) over the near term.

Investing 100K would give you a risk exposure of roughly $68 per basis point move in 7 year Treasury note yield (a basis point is 0.01%).

Why the 7 year instead of other tenors?  The TY future contract usually lead a rally on non-FED induced risk-off, and the cheapest to deliver bond for TY is roughly in the 7 year sector (more like 7.5 year).  So TY and 7s usually move in tandem.  Alternatively, you can open a brokerage account that supports futures, and you can long a single contract of TY (it is a levered investment with a notional value of $100K).

However, if a severe stock market downturn is due to Federal Reserve policy concerns, i.e. the FED hints the next rate hike will come sooner than expected, and they will hike more frequently than market expectations, then 7 year part of the Treasury curve will likely under severe stress (but less so than 3 year and 5 year notes), with flight-to-quality flows (stocks will also do poorly) boosting less interest rate sensitive 30 year Treasuries (or Treasury futures).

Thus, an investor would be taking interest rate risk by investing in Treasury notes and Treasury futures.

Next article10 02 2015 | by Victor Xing | Central Banks

What were the factors behind “Greenspan’s conundrum?”