The probability of an equity market correction over the next few months is slim to none, so there co...
How to Hedge Your Bets This Fall
09/03/2013 7:00 am EST
September is a new game for the stock market and smart investors should get ready for potential changes in the weather, writes John Nyaradi of Wall Street Sector Selector.
The ambivalence of August has brought some ups and downs for the stock market, but when the vacation season ends, we usually see trading volume increase and a full schedule of potentially catastrophic issues, which must be addressed by September’s stock market.
Those who procrastinate and put off rebalancing their investment portfolios until after Labor Day might find themselves blindsided by abrupt developments in the stock market. The shrewd investor must know how to dodge those bullets, while still making profits on some carefully selected positions. During the heyday of the quantitative easing program, it was easy to select a successful stock, with the Fed’s liquidity pump running at full throttle, providing an impressive level of demand for even the lamest of equities.
September’s stock market brings us a number of events, which facilitate the stock market’s worst enemy: uncertainty. At the top of this list is the one event, which is thoroughly discussed day and night: the September 17-18 monetary policy meeting of the Federal Reserve’s Federal Open Market Committee (FOMC). Most economists and commentators expect that at this meeting, the FOMC will vote to proceed with the endlessly debated taper of its bond-buying program, which has been a key element in the quantitative easing effort.
In addition to keeping the federal funds rate near zero, the second element of the quantitative easing agenda consists of monthly purchases by the Fed, amounting to $45 billion worth of Treasury securities (bonds, bills, notes, coupons, etc.), as well as $40 billion in agency mortgage-backed securities. If the anticipated $15 billion cut is made from the monthly purchase, there must be enough interested buyers to pick up the slack, or else the yields increase and the value of the unwanted security falls.
The taper of quantitative easing opens a number of possibilities for “nightmare scenarios,” such as: the consequences resulting from Treasury bond yield spikes (higher taxes needed to service the national debt, budget cutbacks, higher interest rates, credit unavailability, etc.); a stalled job market—as employers become reluctant to expand payrolls during a period of economic uncertainty; a setback in the housing market recovery, as mortgages become too costly for buyers due to higher interest rates and finally, the risk of increased corporate debt, since it will cost more for corporations to borrow money, the higher interest rates will add to the company’s debt burden.
September also brings the return of Congress and the early shots in another battle over the debt ceiling.
Our overseas trading partners have their own potential elements of chaos to contribute to the mix. In Japan, Prime Minister Shinzo Abe can’t seem to find that crucial “third arrow” of his “Abenomics” program. Although Prime Minister Abe has promised a number of reforms, he has yet to deliver on the bulk of them. In Europe, the region’s largest economy—Germany—has elections scheduled for September 22. Greece still remains as a bundle of unresolved crises, with an unemployment rate approaching 28 percent and almost no tax base.
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Once the summer ends, most of these stock market issues will be back in the spotlight. As a result, uncertainty will abound, threatening stock prices. The careful investor will need to plan ahead in order to avoid being caught off-guard when an earth-moving development arises, sending an army of red numbers to invade retirement accounts, and stock portfolios.
With so much uncertainty ahead, one can consider one or more of the following ETFs, either as a directional trade or as portfolio insurance, a hedge against potential September stock market declines.
ProShares Short Dow30 ETF (DOG) – This ETF Is designed to obtain daily investment results, which correspond to the inverse (-1x) of the daily performance of the Dow Jones Industrial Average (DIA). DOG invests in derivatives which ProShares Advisors believes, in combination, should have similar daily return characteristics as the inverse (-1x) of the daily return of the Dow Jones Industrial Average.
ProShares Short S&P500 ETF (SH) – This ETF Is designed to obtain daily investment results, which correspond to the inverse (-1x) of the daily performance of the S&P 500 (SPY) Index. SH invests in derivatives which ProShares Advisors believes, in combination, should have similar daily return characteristics as the inverse (-1x) of the daily return of the S&P 500 Index.
Ranger Equity Bear ETF (HDGE) – This ETF is designed to obtain capital appreciation through short sales of domestically traded equity securities. The Sub-Advisor seeks to achieve the HDGE investment objective by short selling a portfolio of liquid mid- and large-cap US exchange-traded equity securities, ETFs registered pursuant to the 1940 Act, ETNs, and other ETPs. The Sub-Advisor implements a bottom-up, fundamental, research driven security selection process that seeks to identify securities with low earnings quality or aggressive accounting that may tend to mask operational deterioration and bolster the reported earnings per share over a short time period.
Cash – As quantitative easing weakened the dollar, it seems likely that the taper could strengthen the dollar. If interest rates continue to rise, savings accounts and certificates of deposit might actually start paying something again. Beyond that, cash is the ultimate hedge in times of stress, and so raising cash is a strategy that many money managers are currently considering and deploying. Cash is king in rough stock market environments.
Put Options – Put options on currently held positions offer the opportunity to offset declines in positions you don’t want to sell and can be cheap portfolio insurance should the September weather turn ugly and foul.
Bottom line: Significant storm clouds for the stock market are gathering on the horizon as the “lazy, hazy, crazy days of summer” draw to a close. Smart investors will be ready for potential changes in the weather of September. Wall Street Sector Selector is in “red flag status,” expecting lower prices ahead.
By John Nyaradi, Publisher, Wall Street Sector Selector
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