The AI super bull market still has room for imagination, but Wall Street has quietly prepared "two types of insurance": to guard against slow declines eroding returns, as well as to protect from sudden crashes.

Despite market pricing for an interest rate hike at the next FOMC meeting (this week's September policy meeting) climbing to nearly 90%, the S&P 500 and Nasdaq Composite Index still closed strongly higher last Friday, rising 0.86% and 0.96% respectively, mainly supported by a drop in oil prices as tensions in the Middle East eased.

On Friday, September 11, U.S. August headline CPI rose by 0.4% month-on-month, and core CPI rose by 0.3% month-on-month—both accelerating from July, but the year-on-year increase for the headline CPI remained flat at 3.4%, and the core CPI annual increase actually fell to 2.4%. Thus, a more accurate interpretation is that there’s a short-term rebound in price pressures, but not a broad-based deterioration across all inflation indicators.

English noticed that according to some veteran Wall Street analysts, the resilience of the stock market and demand for hedging amidst surging long-term U.S. Treasury yields, rising inflation, increased rate-hike expectations, and ongoing geopolitical tensions are not contradictory: some experienced traders and investors still wish to retain upside equity gains, but differ on whether risk will unwind through “slow valuation compression,” or a “sudden large-scale leveraged unwinding.” The former has led to conditional protections against sliding markets, while the latter supports tools with strong convexity like VIX call options, reflecting diversification in risk management rather than consensus that the U.S. or global stock bull market has ended.

The AI bull market faces a profit test, as global capital begins hedging against two different types of declines

After the slightly higher-than-expected CPI release, Wall Street giant Goldman Sachs shifted from forecasting the Fed to hold rates steady at the September meeting to now betting on a 25 basis-point hike this week, expressing a relatively cautious stance about the path after September. However, a Goldman Sachs research note over the weekend offered a bullish, “profits overpower all” logic for a continued long-term bull market in U.S. equities since ChatGPT swept the world in 2022—projecting S&P 500 earnings-per-share to reach $340 in 2026, a 24% year-over-year increase from a high base, and $385 in 2027, up another 13% year-over-year.

Meanwhile, the forward PE ratio dropped from 22x at the start of the year to 19x, illustrating that rate headwinds have already compressed valuations. Historically, three months after the start of a hiking cycle, the S&P 500 averaged a 2% drop, but was up 9% on average twelve months later. These figures do not support the idea that “the start of Fed tightening must end the bull market,” but cannot guarantee future returns will precisely match history; Goldman emphasizes it’s critical whether profit realization trends can offset further valuation declines.

For the current equity bull market, a single Fed hike is not cause for alarm. At least historically, what really threatens the bulls is a full-fledged tightening cycle, not isolated moves.

The chart below, compiled by institutions, details the twelve times since 1945 the S&P 500 declined by 20% or more into a bear market, plus four times when losses hovered between 18-20%. Six bear markets occurred after tightening cycles, with the economy then entering recession; three came after tightening cycles but without a recession; one coincided with the COVID-19 recession; and only two involved neither tightening nor recession. In this comparison, a tightening cycle is defined as at least two hikes totaling 100 basis points or more.

Goldman’s analysts unanimously agree that AI will deliver sustained, strong earnings growth, and the “AI overpowers all” bullish logic remains robust—namely, that the AI theme will thoroughly override all negative factors, including inflation, geopolitical turmoil, and surging U.S. Treasury yields.

From the perspective of applied AI and data center engineering, as smarter AI agent workflows take on more long-range tasks, multi-round reasoning, and near-limitless high-performance tool calls in the future, there will be explosive demand for core computing, DRAM/HBM memory, data center NAND storage systems, server CPUs, high-performance networking equipment, high-speed optical data center interconnects, and other AI infrastructure resources. From an investment point of view, these workloads must translate into paid orders, real deliveries, data center-level equipment utilization, and cash collections.

Last Friday, Dell and HPE stocks surged about 12% each, showing the market remains eager to chase computing power growth opportunities backed by corporate earnings. However, Goldman also cautions that capex brings depreciation, financing, power, and maintenance costs, and that there's still a test between computing power demand growth and actual returns to shareholders—measured through profit margins and return on invested capital.

Goldman further notes that the reason and pace of rate hikes matter more than any single level: If higher rates mainly reflect stronger growth and improved productivity, corporate profits could offer some cushion; but if they stem chiefly from energy supply shocks, inflation risk premium, or fiscal financing pressure, they can simultaneously push up discount rates, squeeze profits, and eat into consumption. Its call on long-term fixed-rate debt at large corporations means legacy debt costs will pass through slowly, but doesn’t remove new AI project financing and refinancing pressures. The global AI supply chain can share in demand growth, but will see significant divergence due to financing structures, energy costs, and customer concentration.

The U.S. equity options market is signaling—even if the long-term profit outlook is unchanged, holdings may be subject to two starkly different downturn paths. A VIX around 15.5 does not automatically mean hedges are cheap; if realized volatility is even lower, premiums paid for volatility could still be high. In the short term, put options may lose time value if drops are limited or too gradual. Betting on “index down, VIX down” dual-binary options requires both contract conditions to be met and cannot substitute for crash protection.

Over the past few weeks, over 275,000 large block trades of October and November VIX call options reflect another cohort of Wall Street traders and investors seeking protection against sudden shocks. For the ongoing AI-driven super bull trend sweeping global equities, a more grounded forecast is that—while surprising, strong profit growth from AI could support long-term upside, Wall Street institutional investors are now pricing for both valuation compression and liquidity surprises separately, and the bull’s fate hinges on the realization of growth rather than whether risks are ignored.

Crash hedging or slow grind protection? Traders seeking equity hedges are split between guarding against sudden slumps versus gradual drawdowns

As higher rates and oil prices stall stock advances, hedging investors are divided: Should they brace for sharp sell-offs or slow declines?

Recently, several factors have worked against stock market hedgers. The S&P 500 has mostly chopped sideways since late May, and in several episodes this year, upward swings saw greater realized volatility than declines—producing the so-called “rising price, rising volatility” phenomenon in market parlance.

Smaller magnitudes of volatility—especially to the downside—have made some traders less willing to pay up for short-term puts as protection, since premium costs may decay over time if no big sell-off materializes. Thus, while some are buying CBOE VIX calls or S&P 500 puts, others are taking a more creative approach to positioning for declines.

Antoine Porcheret, Citi’s head of institutional structured products for the UK, Europe, Middle East, and Africa, said, “As the ‘rising price, rising volatility’ pattern reverses, we’re seeing some trades betting on ‘falling price, falling volatility’—for example, using dual-binary options linked to S&P 500 declines and VIX drops to target slow-grind markets.”

As shown above, S&P 500 option premium—the VIX risk premium—remains near the upper end of the 2022–present range.

In the past few years, “slow grind lower” has been a popular phrase and trade thesis, as some professional traders and investors see mild selloffs, not sudden crashes, as scenarios worth both hedging and speculating on.

These dual-binary trades—betting both stocks fall and volatility subsides—reflect the current lack of shock and surprise in the AI theme and geopolitical risk narrative, making the case for holding volatility longs less robust. Even with VIX now around 15.5, below the four-year average, it still sits at the high end of its range relative to realized volatility.

Market events such as the U.S. nonfarm payrolls report once triggered large swings, but now, unless surprises abound, markets may quickly calm down.

Nevertheless, even as economic headline risk has faded, equities appear highly rate-sensitive. Thus, all eyes are on this week's Fed rate decision, with market expectations skewed toward a hike. The chart above shows the correlation compilation and summary between S&P 500 index and rates.

As long-term U.S. Treasury yields reach multi-year highs, options designed to profit from equities dropping while rates rise—an inflationary “stagflation” scenario—have attracted flows since earlier this year. JPMorgan strategists recently recommended dual-binary options, with leverage, to bet this scenario persists through year-end.

There are still signs traders and investors are building higher-convexity bets, expecting volatility could surge if the stock rally faces multiple threats. Besides higher rates, these threats include ongoing U.S.-Iran tensions keeping oil prices high and moves supporting a stronger yen—which may spark carry trade unwinds akin to the August 2024 stock market dive and volatility spike.

As seen above, demand for VIX call options is robust, “vol-of-vol” skew is elevated, and convexity-pricing metrics are expensive.

This prompts some traders and investors to choose direct VIX call purchases for hedges, and the widespread appetite for “vol-of-vol” convexity is evident from the skew in VIX calls. More than 275,000 large block trades of VIX calls for October and November have been made in recent weeks.

Porcheret also noted, “The main underlying theme has consistently been protection flows. Direct long-vol trades are more selective, such as buying knock-in forward starting variance contracts that only give you volatility exposure when markets rise.”

And although some leveraged positions are still pricey, there are still experienced Wall Street traders and investors willing to be on the other side, collecting premiums.

Premialab CEO Adrien Geliot remarked, “In fact, we see demand on both sides: traders and investors have growing interest in systematic protection and convexity, but are continuing to allocate to volatility-selling strategies to capture premium and enhance returns. The crucial difference more and more relates to portfolio goals and implementation, not a wholesale switch from short-vol to long-vol positioning.”