Hedge the Market Over the Next Two Months

 |  Includes: GNR, HYG, IXC, OIL, PSQ, SH, SLV
by: Todd Feldman

In several recent articles we have looked back at the US stock market history to detect any similarities using our BFIA measures. Our measures have indicated that 2004 appears to be a similar period to 2011.

We have actually found that the percent changes in our measures are following a very similar pattern to the end of 2003 to the beginning of 2004. We have calculated the percent change in our measures from one week to the next. If the percent change is positive it means the US stock market has fallen significantly for that week.

In the figure below it can been seen that the 2010-2011 percent change in our measure is one to two weeks behind our 2003-2004 measure.

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Figure 1: % Change in BFIA Measure Comparison 2004 to 2011

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If we are to assume that the 2011 measures will continue to follow the 2004 measures in the short-term, then March and April will be down months and May and June will be up months.

Based on this information, how should investors protect themselves? First, the next two months will be down months and therefore, the time horizon for hedging is two months. Investors can use derivatives to hedge their portfolios by selling futures contracts on a US index such as the Nasdaq or put options on a US stock index with a two month expiration.

If one is not inclined to invest in derivatives, then ETFs that short the US market, such as SH or PSQ, will accomplish your goal. Your level of exposure to a short position depends on your risk aversion. One idea is to short about half the value of your portfolio as a hedge and buy long investments such as high yield investments, energy, and precious metals, which our model likes at this time. These investments will perform well in an up market and may perform well in a down market.

Therefore, we recommend forming a portfolio for the next two months with energy and precious metal investments in companies related to these industries and in the commodities themselves, such as HYG, SLV, IXC, OIL, GNR. We know these investments are at 52 week highs. However, at this time we do not see any pullbacks for the next two months and the model has no signal that these investments will correct.

Currently, we believe that one should pull out of these investments and back into equity markets such as the US in two months time. Our model can change quickly and we will be sure to inform the readers.

Disclosure: I am long HYG, GNR, IXC, SLV.