The AI super bull market still has room for imagination, but Wall Street has quietly prepared "two types of insurance": guarding against a slow grind lower that erodes returns, while also guarding against a sharp crash.

Title context: The AI super bull market still has room for imagination, but Wall Street has quietly prepared "two types of insurance": guarding against a slow grind lower that erodes returns, while also guarding against a sharp crash. Text: Although market pricing for a rate hike at the Federal Reserve's next FOMC monetary policy meetingthis week's September policy meetingrose to nearly 90%, the S&P 500 and the Nasdaq Composite still closed up 0.86% and 0.96% respectively last Friday with strong resilience, with the pullback in oil prices driven by news of easing geopolitical conflict in the Middle East providing important support. On Friday, September 11, U.S. August headline CPI rose 0.4% month over month and core CPI rose 0.3% month over month, both faster than in July, but the headline year-over-year gain was unchanged at 3.4%, while the core year-over-year gain actually fell to 2.4%. Therefore, a more accurate judgment is that short-term price pressures have rebounded, rather than that all inflation indicators have deteriorated across the board. Note that in the view of some veteran Wall Street analysts, the resilience of the stock market amid surging long-dated U.S. Treasury yields, rising rate-hike expectations caused by accelerating inflation, and tense geopolitical maneuvering is not contradictory to the demand for capital to hedge risk: some veteran Wall Street traders and investors still want to retain stock market gains, but they disagree on whether risk will be released through a "slow compression of valuations" or a "sudden large-scale deleveraging liquidation." The former drives conditional protection against a slow decline, while the latter drives instruments such as VIX call options with strong convexity payoffs, reflecting a divergence in risk management approaches rather than a market consensus bet that the bull market in U.S. stocks or even global stocks has ended. The AI bull market enters an earnings test, and global capital begins buying insurance for two types of declines After the slightly stronger-than-expected CPI data was released, Wall Street financial giant Goldman Sachs shifted from forecasting that the Fed would stand pat at its September monetary policy meeting to betting that the Fed will choose to raise rates by 25 basis points this week. For the path after September, Goldman's stance is relatively cautious. However, in a research report published late last week, Goldman laid out the "earnings trump everything" bullish logic that the long-term bull market in U.S. stocks since ChatGPT swept the globe in 2022 will continue stronglyprojecting that S&P 500 earnings per share will reach $340 in 2026, implying a sharp year-over-year increase of 24% from an already high base; and further reach $385 in 2027, up 13% year over year. At the same time, the forward price-to-earnings ratio has fallen from 22 times at the start of the year to 19 times, indicating that interest rate headwinds have already been reflected through valuation compression. Its historical sample shows that three months after the start of seven rate-hike cycles, the S&P 500 fell by an average of 2%, but twelve months later it rose by an average of 9%. These data do not yet support the idea that "once the Fed begins raising rates, the bull market trajectory is bound to end," but they cannot be used to prove 100% that future investment returns will necessarily replicate history; Goldman emphasized in its research report that what really matters is whether the earnings realization trend can offset a further decline in valuation factors. For the current stock bull market, a single Fed rate hike itself is not something to worry about. At least historical data show that what truly threatens the bulls is a complete rate-hike cycle, not a single move. The chart below, compiled by institutions, provides a detailed and precise breakdown of the 12 bear markets since 1945 in which the S&P 500 fell by 20% or more, as well as another four declines of between 18% and 20% that approached bear-market territory. Among them, six bear markets occurred after rate-hike cycles, with the economy subsequently falling directly into recession; three occurred after rate hikes but were not accompanied by recession; one occurred simultaneously with the COVID-19 pandemic recession; and only two involved neither rate hikes nor recession. In this comparison, a rate-hike cycle is defined as at least two rate increases with a cumulative magnitude of 100 basis points or more. Goldman Sachs analysts unanimously stated that AI can provide a source of sustained and strong earnings growth, and that the "AI trumps everything" bullish logic remains firmnamely, the strong bullish logic that "the AI theme comprehensively overwhelms all negative factors, including inflation, geopolitical crises, and surging U.S. Treasury yields." From the perspective of actual AI applications and data center engineering, if future more powerful AI agent-style workflows take on more long-horizon tasks, multi-turn reasoning, and nearly endless high-performance tool calls, they will continue to explosively expand demand related to a series of AI data center infrastructure resources, including core computing, DRAM/HBM memory, data center NAND storage systems, server CPUs, high-performance networking equipment, and high-speed optical interconnects for data centers. From an investment perspective, these workloads must paid orders, actual deliveries, data-center-level equipment utilization, and cash collection. Last Friday, shares of Dell and Hewlett Packard Enterprise both rose sharply by about 12%, reflecting that the market is still willing to chase computing power growth opportunities supported by corporate earnings. But Goldman also warned that capital expenditure simultaneously brings depreciation, financing, electricity, and maintenance costs, and that between growth in computing power demand and growth in shareholder returns, there remains the test of profit margins and return on invested capital. Goldman also said that the reason for and speed of rising rates matter more than any single rate level: if rate increases mainly reflect improving productivity, corporate earnings may provide a buffer; if they mainly stem from energy supply shocks, inflation risk premiums, or fiscal financing pressures, they may simultaneously raise discount rates, squeeze profits, and weaken consumption. Its judgment regarding large companies' long-term fixed-rate debt means that the cost transmission from existing debt is slower, but it cannot eliminate the pressure from financing new AI projects and future refinancing. The global AI supply chain can share in demand expansion, yet will still show clear divergence due to differences in financing structures, energy costs, and customer concentration. The U.S. equity options market, meanwhile, is signaling that even if the long-term earnings judgment has not changed, positions may still face two very different decline paths. A VIX around 15.5 does not automatically mean protection is cheap; if actual market volatility is lower, the volatility premium paid may still be too high; short-term put options may lose time value because the decline is insufficient or too slow. Double binary options betting that "the index falls and the VIX also falls" require the conditions specified in the contract to be met simultaneously and cannot replace crash insurance. The bulk buying of more than 275,000 VIX call contracts for October and November over the past few weeks reflects another group of Wall Street professional traders and investors seeking protection against sudden shocks. For the AI super bull market still sweeping global equities, the more well-founded substantive judgment is that the stronger-than-expected and robust earnings growth trajectory around AI may still support long-term upside, but Wall Street institutional investors are pricing valuation compression and liquidity shocks separately, and whether the bull market continues depends on the trajectory of earnings realization, not on whether risk is being ignored. Guard against a crash or a slow decline? Traders seeking hedges for the stock market rally are split over whether to protect against a crash or a slow decline As rising rates and oil prices stall the stock market rally, investors seeking hedges are divided: should they guard against a rapid selloff or a slow decline? Recently, several factors have worked against stock market hedgers. The S&P 500 has mostly traded in a range since the end of May, and at several points this year, realized moves during advances were larger than during declines, producing what market terminology calls a "prices up, volatility up" phenomenon. Smaller movesespecially declineshave made some traders more reluctant to pay up to directly buy short-term put options as protection, because without a sufficiently large decline, option premiums may erode over time. As a result, while some traders and investors are buying Cboe Volatility Index call options or S&P 500 put options, other traders and investors are using more creative ways to position for declines. Antoine Porcheret, head of institutional structured products for the UK, Europe, Middle East and Africa at another Wall Street financial giant, Citigroup, said: "As the 'prices up, volatility up' pattern reverses, we are seeing some trades begin to bet on 'prices down, volatility down'for example, through double binary options betting that the S&P 500 falls and the VIX declines, positioning for a slow downward move." As shown in the chart above, the S&P 500 options premiumthe VIX risk premiumremains near the upper edge of its range since 2022. Over the past few years, "slow decline" has been a popular phrase and a popular trade idea, because some professional traders and investors believe that a mild selloff rather than a sudden crash is a scenario worth hedging and speculating on. These double binary option trades betting that stocks decline while volatility falls reflect a general lack of shock and surprise in the current AI theme and geopolitical risks, which makes the case for holding long volatility less clear. Even though the VIX is currently around 15.5, below its average over the past four years, it is still near the upper edge of its range relative to actual market moves. Events such as the U.S. nonfarm payrolls report once frequently triggered large market swings, but now, if the result does not contain a shocking surprise, the market may quickly calm down. However, although risks from economic news have diminished, the stock market still appears highly sensitive to interest rates. Therefore, all eyes will be on this week's Fed rate decision, with market expectations currently leaning toward a rate hike by the U.S. central bank. The chart above is a compilation and summary of the correlation between the S&P 500 and rate movements. As long-term U.S. Treasury yields rose to multi-year highs, option payoff structures betting on a stagflation scenario of falling stocks and rising rates attracted inflows earlier this year. JPMorgan strategists recently recommended double binary options to take leveraged positions on this scenario continuing through year-end. Of course, there are still signs that traders and investors are building bets with stronger convexity payoffs, expecting volatility to jump as the stock market rally faces multiple threats. In addition to rising rates, these threats include high oil prices amid the ongoing U.S.-Iran war, and moves supporting a stronger yenwhich could trigger carry trade unwinds similar to the stock market plunge and volatility spike in August 2024. As shown in the chart above, demand for U.S. equity VIX call options is strong, the skew in the "volatility of volatility" is elevated, and indicators measuring convexity pricing are expensive. This has prompted some traders and investors to firmly choose to hedge by directly buying VIX call options, and broad market demand to buy convexity in the "volatility of volatility" can be seen in the skew of the index's call options. Over the past few weeks, more than 275,000 VIX call contracts for October and November were bought through block trades in total. Porcheret said: "The dominant theme in flows has been hedging activity. Trades that are directly long volatility are more cautious, such as buying knock-in forward-starting variance contracts, a structure in which you only hold volatility exposure if the market rises." Moreover, although some leveraged bets remain expensive, there are still veteran Wall Street traders and investors willing to take the other side of the trade and seek to collect premiums. Adrien Geliot, chief executive of Premialab, said: "In fact, we see demand on both ends: traders and investors are showing increased interest in systematic protection and convexity, while continuing to allocate to volatility-selling strategies to earn carry and enhance returns. The key difference is increasingly reflected in portfolio objectives and implementation methods, rather than a market-wide shift from short volatility to long volatility."