US equity funds took in $119.2bn in the week ending 17 June, according to Bank of America, while cumulative inflows for 2026 have reached $739bn and are heading towards a record. Yet the S&P 500 has suffered several sharp drops in recent weeks, even after gaining just under 10% since the start of 2026, following double-digit advances in each of the previous three years. The uneasy price action sits alongside concerns over stretched valuations, the prospect of higher Federal Reserve rates and geopolitical risk.
Corporate earnings have helped ease some valuation pressure, with multiples retreating from multi-year highs, including the P/E ratio. Even so, the CAPE ratio comparing the S&P 500’s return with US Treasury bonds has fallen to 1.3%, its lowest level in a decade, and rising Treasury yields risk weighing on equities. Bond yields have climbed on expectations of tighter Fed policy in September, although continued strong US economic data could shift rate-hike expectations to July. Separately, uncertainty persists in the Middle East: while a US-Iran deal has been discussed, escalating tensions between Hezbollah and Israel have revived threats of air strikes and potential closure of the Strait of Hormuz.
Volatility, Defensive Positioning, And Rate Hike Risk
Given the market’s unease despite solid fundamentals, we see the recent sharp drops as a warning sign. The CBOE Volatility Index (VIX) has jumped above 20 several times this past month, signaling that traders are actively buying protection. We believe this is a prudent time to protect gains from the year’s rally rather than chase further upside.
We are therefore buying S&P 500 index put options with expirations in late July and August. This strategy provides a direct hedge against a market pullback triggered by either a hawkish Fed or geopolitical shocks. It allows us to cap our downside risk while maintaining our core long positions in high-conviction names.
The risk of a Federal Reserve rate hike is our primary concern, as fed funds futures now imply a nearly 50% chance of a hike at the July 30th meeting. The upcoming Consumer Price Index report on July 15th will be a critical data point that could solidify these expectations. A higher-than-expected inflation number would almost certainly send equities lower, making defensive positions essential.
Valuations, Sector Risk, And Geopolitical Hedges
Even with the excitement around AI, we are wary of broad market valuations, especially with the CAPE ratio signaling poor long-term returns relative to bonds. Historically, during periods of rising rates, non-profitable tech and cyclical stocks tend to underperform significantly. We are using derivatives to reduce our exposure to these vulnerable sectors while maintaining our focus on profitable AI leaders.
The escalating conflict in the Middle East presents a clear and present danger to market stability. An expansion of the conflict could cause Brent crude oil prices, currently hovering around $90, to surge back above $105, a level that would reignite inflationary pressures. To counter this, we are purchasing out-of-the-money call options on energy ETFs and puts on transportation stocks as a cost-effective hedge.
