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Today’s market offers many alternative ways to pursue profits and hedge risk
As a South Floridian, the best analogy I can make to the last few years in the stock market is to hurricane season. The thing about hurricanes is that they have 3 parts. 2 of them are bad. The first band of powerful wind and rain can be very destructive.
Then, the “eye” of the hurricane passes over, and for a little while, it’s bright and sunny. That’s because the eye is that hole in the middle of that giant, gyrating circle of bad weather. The last part of the storm is another batch of heavy wind, rain, and destruction. Then, the hurricane ends, and the weather clears.
As the actual hurricane season gets underway in the U.S., here is a stock market summary, in tropical terms:
Early 2018: storm on the horizon, potential to turn into a major one.
Late 2018: front side of the storm hits. S&P 500 falls nearly 20% before rallying on Christmas Eve.
2019 and early 2020: a very large “eye” of the hurricane passes over the S&P 500. As with a real hurricane, the weather is bright and sunny. You almost forget that you are in the middle of a hurricane. But then…
February, 2020: the so-called “dirty side” of the storm hits. And it hits hard and fast. S&P 500 falls over 33% in 5 weeks, the fastest such decline on record.
Late March, 2020: as fast as the dirty side of the hurricane arrived, it leaves just as quickly. The market rallies again, in historic fashion. And, even though most of the market is still well below where it was earlier this year, a small number of big, iconic FAANG stocks make it look like the storm is over. In fact, I will agree that the hurricane IS over.
But there is one problem. As with the weather version of hurricane season, there can be another storm. Hurricanes are like roaches in that respect. There’s never just one.
In the midst of the crisis, I showed you some parallels between the 1930s and the current time. The ‘30s were, metaphorically speaking, one of the toughest investment hurricane seasons ever.
Are we headed for another stock market hurricane like that one? To be clear, I don’t know. And neither does anyone else. You can’t control the weather or the markets (well, unless you are the Fed, but I digress).
I DO know this: you can prepare to survive an investment hurricane. Any investor can. You just need the tools and willingness to do the preparation.
Remember, too, that you don’t need to “sell out” (literally and figuratively) to the possibility of a hurricane hitting your portfolio. Investing is better thought of as a balancing act. That’s not necessarily between stocks and bonds and cash, as many in my industry would have you believe.
Instead, the balancing act is simpler. It is between pursuit of return, and the potential for major loss. What is major loss? Everyone’s answer is different. So start by asking yourself what “major” means. Sort of like we here in SoFla have different definitions of what “major” damage is to our homes and neighborhoods. Everyone sees it differently, from the panic prior to the hurricane, to the aftermath.
So, here are a few tips on how I am preparing for whatever comes next. It’s storm season, after all.
S&P 500: break it down!
I don’t know if there has been a time in my 34-year career where the stock market seemed more like a “market of stocks.” That is, there are many different segments or slices of the S&P 500 and beyond the S&P 500. They are moving at different paces and directions. This is always the case, but I see more opportunity in what some call “sector rotation” than in the past.
Beyond stocks
As investors, we are naturally a stock market culture. But the world situation today has set in motion many interesting areas that are not within the equity asset class. Whether it is segments of the bond, commodity or currency markets, there is a lot to consider now. And, ETFs make it easier to do that slicing and dicing. So does something called “Direct Indexing” which I will discuss in a future article.
Learn to hedge!
As someone who refers to himself informally and formally as a “Hedged Investor,” it should come as no surprise that I think there has never been a better time to hedge your portfolio. If you are over age 50, I think it’s mandatory. If you are younger, it may still help you grow your wealth at a stronger rate over time.
That’s because hedging is much more than just “disaster protection.” It could take the form of arbitrage investing (buying a long and short security with the goal of keeping returns in a narrow range, but still aiming to profit instead of “going to cash”). It might be as simple as understanding how options or inverse ETFs work. Or, it could be a matter of converting your brain from “buy and hold” all the time, to a mix of that and more tactical management.
Regardless of how you proceed from here, know that the potential for a string of stock market hurricanes is very real. So, regardless of what actually happens, don’t you want to at least be prepared? It’s better than having to deal with the aftermath.
Related: Thinking Of Using Options In Your Portfolio? Read This First.