3 Ways to Prepare for a Possible Market Decline

Nothing seems to shake the market. Investors (speculators?) shrug off potential shoes in the face fearing they’ll miss the rising market. The mood has changed significantly since early March when the S&P bottomed below 680. But after a 30% rally in less than two months, stocks are now overbought and will at best pause for the next several months. Indicators and technicals from low volume to failed resistance are proof of an exhausted market. The pop-then-drop, i.e. a rally above resistance at 880 to 900 to draw in anxious investors then the pull back, is a possibility and could keep the market alive for the next week or so. Then my guess is we will see a pull back to a range of 700 to 750 on the S&P.*

SHOE SHOCK

But experienced investors know that stocks don’t go down simply because they’re expensive. So what are some of the possible scares that can trigger stocks to sell off? I’ve compiled four festering problems that could blossom and grab investors’ attention:

1) Sharp increase in home foreclosures when major banks lift foreclosure moratorium

2) Stress test, now treated as a benign event, in time could show ongoing weakness in major banks

3) World events finally become too heavy and investors once again panic: swine flu pandemic, Pakistan or Iran nuclear issue are a few possibilities

4) Continued job losses show recovering consumer not as strong as suspected

CONTRARIAN INVESTMENT IDEAS

There are several ways investors can prepare for a possible market decline other than outright selling of long positions:

1) Gold has retreated from the high near 1000 reached in late February to just above 870. Strong support is at 850 and one of the above events could push gold back to the 1000 level.

2) Healthcare stocks, pharmaceuticals in particular, have not participated in this rally even though they represent one of the only sectors showing increasing year over year earnings. Johnson and Johnson (JNJ) and Abbott Labs (ABT) are two good ideas.

3) Bullish call spreads on a market short ETF such as the Ultra Short S&P (SDS) or even more aggressive the Ultra Short Financials (SKF). It must be understood that a call spread has the potential of 100% loss but, unlike common equity, this risk can be determined before placing the spread. It is a form of insurance against a market decline.

I don’t wish for catastrophic events and feel for those who are unfortunately affected. But, like a good boy scout, one must be prepared.

*Note the S&P 500 is at 880 as of the writing of this commentary.

Disclosure: Hillbent.com, Inc. or its affiliates may own positions in the equities mentioned in our reports. We do not receive any compensation from any of the companies covered in our reports.

Comments

[Old Trader:]

Regarding the increase in forclosures....the other day, there was a piece in Bloomie about exactly that happening (a spike in forclosures, as the moratorium on them ends).

I also found it of interest that the official release of the results of the stress test have been pushed back.

Finally, we've got a resumption if BFF (Bank Failure Fridays) as its called on the Calculated Risk blog. So far, they been smaller institutions, so its below the MSM radar, for now. (Btw, we're up to 31 failed banks, as of 5:50 pm, CDT, and there's often later announcements from the west coast).

May 01 06:54 PM

[dcb:]

when goldman decides to let the market go down it will happen, but not until then. if you look at trading volumes on NYSE they are the market at this time.

May 02 05:55 PM

[Bull-Shit:]

Notice Of Defaults spiked in Q1 '09... Tsunami of foreclosures will drown the bulls in Q2 thru Q4!!!

www.doctorhousingbubbl.../

May 03 02:59 PM

[Market Sniper:]

Long, short, as long as it moves. Trade what you see and not what you think. May continue to rally, you make money. It may retrace, you make money. Just keep it very short term with stops and you cannot get hurt badly and may even make a few dollars. Only price pays.

May 03 08:01 PM

[Market Sniper:]

Personally think that this is still a bear market rally and potentially one of the great bull traps of all time. However, the market does not care one whit what I think or anybody else thinks for that matter.

May 03 08:03 PM