Time to hedge portfolios?

Markets have run really hard since the depths of the covid-crash last year. When looking specifically at U.S. markets, there are some signs of stress appearing. Likely one of the more important signs is market breadth, which has been slowly deteriorating for months. The market seems very complacent though. Sentiment is practically in the middle of road. After Friday there are emerging signs of ‘panic’, although not on a large enough scale to scare the fund managers. In fact, allocations into equities are the highest they’ve been since the 2009 global financial crisis. This worries us. Which has us asking if it’s time to hedge portfolios?

Offshore trade ideas
S&P 500 (SPY)

It is rather challenging to tell signal from noise here right now. The key here is to discern whether or not this is a technical sell signal, or if this is just another dip that we should buy. We are looking at this chart in a number of different ways;

Weekly chart
The dotted, lower boundary of the rising wedge is plotted using the weekly real body closes. Very strictly speaking, it has triggered the sell.

Daily chart
The dashed, lower boundary of the rising wedge is plotted using the candlestick tails on daily candles. Now it appears that there has been no sell signal triggered yet.

An interesting perspective from ZeroHedge.com

The Pavlovian investor has been taught to buy the dip, but will it work going forward just because it has worked well so far? That is the question many investors are asking themselves at the moment. The current market psychology is extremely complex as the crowd has been rewarded with one behavior; buy the dip. There is a risk of the general investor about to suffer from cognitive dissonance.

Cognitive dissonance is the distressing mental state that people feel when they “find themselves doing things that don’t fit with what they know, or having opinions that do not fit with other opinions they hold.” A key assumption is that people want their expectations to meet reality, creating a sense of equilibrium. Likewise, another assumption is that a person will avoid situations or information sources that give rise to feelings of uneasiness, or dissonance.

Investors know that the market behaves like a cork in water; it always comes back up. Lately the market corrections have been smaller, both in terms of magnitude and time, i.e the buy the dip has been reinforced. Let’s see if those that have bought this last dip will find themselves in the same position as Pavlov’s dogs, waiting for the ringing of the bell, but no meal is following.


The question we are asking ourselves now is; do we need to hedge out a potential 10% to 20% correction, or will the market bounce from here?

Inverse S&P 500 ETFs (SH, SDS, SPXU)

If you’re also thinking that it’s time to hedge portfolios, potential hedging candidates include; SH (1x gearing), SDS (2x gearing) and SPXU (3x gearing), which will all rally if/when the SPY comes down. You will need to calculate your portfolio’s beta to the SPY, then work out how much inverse/negative exposure you will need in order to reduce your portfolio’s beta to 0.

Russell 200 (IWM)

This long consolidation period is starting to look like a long-term distribution pattern. For now, there are still no signals on this market. We would be very concerned if the lower range boundary is breached though.

Time to hedge portfolios?
Dow Jones Transportation Index (DTX)

Earlier this year we’d mentioned a bullish break from a bull flag formation on DTX. It has become clear that the bull flag formation is failing and the DTX has failed to make any significant attempt at a new high. It is now fast approaching the 200 day moving average. Failure of the 200 day moving average to hold could be another major sell signal for the broader market.

Time to hedge portfolios?
Brent Crude Oil

The oil chart is one that we have been bullish on a whole a lot over the last year or so and we continue to be bullish. After it finally retested (and bounce off) the primary trend line, it seems that it is gearing up for another leg higher in the coming months. Overall the market is not without its challenges, although rising geopolitical tensions, hurricanes and rising demand are keeping the oil market in a state of ‘undersupply’. Thus we remain bullish and keep looking for opportunities to take long trades in Oil.

South African trade ideas
JSE Top 40 Index (ALSI)

Well, would you look at that? After around six months of consolidation, the range has finally broken to the downside. Is it time to hedge local portfolios as well?

Time to hedge portfolios?
Sanlam (SLM)

Our SLM short from last week is working rather well so far. We’re happy to move our stop loss to just below entry, basically making the rest of this trade ‘risk free’.

Time to hedge portfolios?
Sasol (SOL)

SOL looking like a decent bullish setup here, especially with a bullish oil backdrop.

Time to hedge portfolios?

We’re talking to Ghosts!

We will be having a series of chats with The Finance Ghost and Mohammad Nalla during the month of September. Our goal is to educate the listeners and to let people out there know about what we do, and how we do it.

Next week we will be taking some of your questions. So if there is anything that you would like to learn about, please feel free to retweet and ask!

Want ideas, insights and research?

*Please note that these trade ideas form part of a larger weekly plan and the value of financial products can increase as well as decrease over time, depending on the value of the underlying securities and market conditions. The risk of loss arising from trading in Contracts for Difference can be substantial. You should carefully consider whether such investments are suitable for you in the light of your circumstances and financial resources.

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Markets change all the time. New fundamental drivers emerge, technical setups mature or fail and our trading plan must adjust in order to keep up with the ever changing environment. Every week we highlight some of the trade ideas that are generated within our client community so that you can stay on top of what we're looking out for and planning to trade at the beginning of each week. 

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