If you had even a fraction of your portfolio invested in equities during September, you probably enjoyed a handsome gain as the markets rallied throughout the worst month for stocks historically. The S&P was up over 8% for the month as concerns over a double dip recession eased and as news was released that the recent recession officially ended in June 2009. However, the markets now stand at a potentially overbought level that even the slightest bad news can give the markets a reason for another significant correction, sending them back into their sideways pattern. The trading range that was established in Q1 has continued throughout the year, and the current price level of the market seems so fragile that it could easily send the market roaring past its current resistance on the right economic news or back down below 1,050 if more uncertainty rises. With no clear cut direction in sight, it would be wise for those who are long equities to pick up hedges against their positions rather then outright cut them.
As we await the start of another fresh round of earnings from Q3, significant economic data will be coming out in the near future that everyone will have their eye on. This week, a handful of employment data will be released as the ADP employment report is due on Wednesday and the unemployment rate will be announced on Friday. Consensus sees an uptick in the unemployment rate to 9.7% from 9.6%, but expect weekly jobless claims to be down to 450k. New jobless claims have seen a downward trend for the entire year, but have failed to impact the unemployment rate significantly which has added uncertainty to the condition of the job market.
click to enlarge
The employment situation can make or break this rally heading into earnings season. The S&P 500 is facing a significant resistance level, and technical indicators are pointing towards a correction in the market. A shortage of volume will only provide fuel to any unexpected disappointment from economic data released.
In the above chart, you could clearly see the S&P is struggling to break through this resistance. RSI had shown overbought and a downturn was pending, which made it hard for the S&P to go any higher especially due to the low level of volume we had been seeing. So far this year, the MACD for the S&P had predicted each downturn at the appropriate resistance level, as the two lines crossed just before the market decline. The MACD is at that level once again, implying that another downturn is imminent should data come out weaker than expected.
However, should the market pull back, I believe it will be temporary and that is why I believe a hedge against the long positions would be wiser than exiting the positions all together. Long term potential for stocks is still bullish, as many big name companies still appear undervalued and have a greater possibility of an adequate return compared to bonds. Bonds have a very limited upside horizon but pose a substantial downside risk at these levels. Fundamentals for stocks still look good, with the DJIA still having a relatively low P/E ratio of 14.5. Dividend aristocrats are starting to become favorites of many investors as the search for yield continues with the 10 year treasury below 2.5%.
There are a variety of options to consider when looking to hedge your portfolio for a short term correction, and the one you should choose depends on your risk tolerance. For those willing to take higher risks, puts on some of the most overbought stocks, including AAPL, NFLX, BIDU, and AMZN, should be condsidered along with positions in inverse ETFs focused on sectors most exposed to the investor's portfolio. For example, a portfolio focused on technology should look for TYP or REW. For the risk averse investor, silver and gold ETFs provide a good hedge to their portfolio. For direct short exposure to stocks, risk averse investors could also look at non inverse ETFs such as DOG or SH.
Keep in mind, these hedges should be short term. A positive earnings season and upbeat economic data could send the S&P to retest 1,225. As always, do your due diligence and consider your investing objectives before you make any move.
Disclosure: No positions in above mentioned securities
