The Rich Are Showing Signs of Stress. Time to Hedge?

So far, inflation and rising

interest rates have largely been little more than a nuisance for wealthy Americans.

Prices for groceries, cars, and airplane tickets have often violated the equilibrium between price and value, but not enough so that anyone with resources felt compelled to make substantive lifestyle changes. These folks were more likely to complain that banks and brokers made it difficult to earn higher interest rates on idle cash than to fret about egg prices or higher vacation expenses.

But the rich may be starting to feel new stresses. Last week,
American Express
(ticker: AXP), whose charge cards are often favored by the well-to-do, told investors that it had increased the amount of money set aside for bad debts to $1.2 billion from $1.1 billion in the previous quarter.

The increase merits noting as a potential warning that consumer spending, which powers the U.S. economy, might be under more pressure than appreciated. If wealthy consumers struggle to pay bills, imagine what that portends for those with lower credit scores and less income.

The point is speculative, but not excessively. The Federal Reserve’s leaders have repeatedly warned that a delay exists between higher rates and slowing economic activity—and that makes AmEx’s higher provisioning a potential indicator of a slowing ahead.

Of course, an accurate analysis of the economy always requires more than a single data point. The challenge is sorting through the noise of the market and economy to identify facts or themes that could be an early warning for whatever may happen next in the markets.

A useful measure—and you should try this out on friends and family—has always been what I call the “PA Indicator.” At a recent party on Eastern Long Island, at the home of someone who manages multigenerational wealth, the conversation turned to what everyone was doing with their personal accounts, or PAs.

Among the handful of couples, the finance people were conservatively positioned. The real estate developer was building another luxury development with sale prices pegged to several thousand dollars per square foot.

The wine, Champagne, and food were excellent, but not enough to overwhelm the consensus feeling that prices had run too far, too fast. Those who were in the market—and many people are perpetually invested because their cost basis in stocks is so low—were hedging with put-spread collars or selling covered calls on stock positions.

Those strategies reduce market risk and broadly express views that securities are more likely to fall than rise. A put-spread collar, after all, entails selling a call option on a security and using the proceeds to buy a put option, while selling another to hedge against a stock decline.

Notwithstanding the dinner party, or AmEx’s plans for higher bad debts, the towns, stores, and restaurants that comprise the Hamptons seem frenzied.

There is little sign of concern about much of anything in New York’s summer playground. This is true in the stock market, too, which is trending higher, and on airplanes, which are packed with people headed on vacations. Everyone looks committed to having as much fun as they can now that the Covid pandemic seems to have ended.

Keep an eye on the signs. We will soon learn if the nascent disconnect between bad debts and the mood in the Hamptons is just coincidental or a sign that a Sword of Damocles is quietly being suspended over investors.

Steven M. Sears is the president and chief operating officer of Options Solutions, a specialized asset-management firm. Neither he nor the firm has a position in the options or underlying securities mentioned in this column.

Email: [email protected]

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