Wise investors not only make bets on what they believe will occur, but also hedge in case their thesis is wrong or mistimed. Recent news reports suggest that many key findings of the Mueller investigation could be released shortly after the Midterm Elections. There are a few indicators that lead me to believe that investors are not taking the risk of these findings seriously. In the worst-case scenario, the details of Mueller’s findings would likely cause a crash in the equity markets. Whether you believe this will happen or not, rational investors need to have a hedge for this worst-case scenario, which would likely cause a fall in the major equity indexes of over 30%. In this short article, I will lay out why investors should take this subject matter seriously, what the effect on the stock market could be and what strategies you can use to hedge your portfolio.
With the forward PE of the S&P 500 close to 17, there likely are not many investors considering the near term risk that Mueller’s findings could have on the financial markets. There seems to be a prevailing theory that Trump is impervious to bad news in the long-run and that this would stay the case regardless of what information Mueller releases to the public. The problem is that if Trump really has been colluding with the Russian Government this whole time, the release of this information will put into question the global alliances between nations, including trade and military agreements. The uncertainty that this scenario brings would be devastating to the stock market in the short-term and I believe it is important to hedge your portfolio prior to the midterm elections and the release of Mueller’s findings.
As difficult it is to predict the exact damage to the price of the equities market in this worst-case scenario, I believe we would at least touch valuations seen the last time the direction of interest rates were an open question to most investors. I would expect to see at least a 30-35% drop in all three major equity indexes. The Nasdaq would likely take the biggest hit because there could be more negative information released about Facebook and Twitter. This is not meant to be a doomsday article, advising you to buy canned goods and hide in a bunker. My hope is that even in a scenario that includes collusion and impeachment, a new administration will work to bring us closer than ever to Europe, which would settle the markets in the long-term.
Gold exposure could be one of the surest bets in this scenario. I am choosing to keep holdings in gold ETF’s, as they will be a liquid way to trade and allow me to buy into stocks quickly, at lower prices during a sell-off. Holding the currency of a stable country that you live in, would also be a good way to have liquidity and bet on stability returning in the long-term. My choice is to do both, with a higher percentage of my assets in multiple gold ETFs, to provide me with liquidity and potential upside in this volatile scenario.
For a few reasons, this trade is the right move for my personal portfolio. I actually believe that a worst-case Mueller scenario is likely, so it would be difficult for me to invest in stocks with that mind-set. If I keep my gold/US dollar exposure through Mueller’s report and it turns out I am wrong, there are many other reasons why a gold position could increase in value going forward. With market valuations far from cheap historically, those scenarios include: a continued trade war hurting company earnings, a shift in the US political landscape after the midterms that scares investors and a potential political conflict with the Prince of Saudi Arabia, which causes a scare in the oil markets (MBS bringing down the markets for a second time). These additional scenarios could make my trade in gold right, even if I’m wrong. If none of these scenarios pan out, gold prices are likely to be range-bound through Mueller’s first report, leaving me the option to sell a portion of my position.
Hedging your bets is such an important part of investing. In order to do it properly, investors need to see the potential scenarios in front of them and correctly identify what could be detrimental to their investment in the future. Currently I believe that equity investors are staring directly at the Mueller investigation and not recognizing it as a potential threat to the major stock indexes. That could prove to be a mistake. I hope this article helps you consider the near-term options to hedge your portfolio, until the public receive more information from Robert Mueller.
Disclosure: I am/we are long GLD, IAU.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.