This week marks the beginning of one of the most seasonally weak periods for stocks. The coming days of August are traditionally among the worst for average S&P 500 performance during the past 22 years … which means investors should brace themselves for some volatility.
Since 1990, the SPX has averaged a loss of 0.9% for the month of August compared to an overall monthly average gain of 0.6% for all months of the year. Breaking it down further, August shows positive returns 57% of the time at an average of 2.3% while losing a dramatic 5.1% the remaining 43% of the time.
The negative tendency of August should have all investors checking their portfolios for a few things.
First, are there any market outperformers that you should be taking profits from? With earnings season more than halfway done, the market could become stagnant as fundamental drivers, outside of economic news, will taper off. Companies that have posted nice earnings-related spikes like Tripadvisor (TRIP) and Herbalife (HLF) should be on your screen as profit-taking opportunities. For our money, trailing stop-loss orders are the best way to take the emotion out of trimming these profits.
In addition to trimming the profit tree, potentially poor August trading means it might be time to hedge your portfolio with exchange-traded funds that can profit when the market declines. Here are a few funds to consider:
ProShares UltraShort Financials
Click to Enlarge Typically, relative strength-leading sectors can turn into the rapidly declining groups as overly excited buyers turn tail and sell. The financial sector — as represented by the Financial SPDR (XLF) — has garnered a lot of buying lately as investors posture for a long-term bull run on the group.
Remembering that what goes up fast can come down fast, too, we like the idea of hedging potential market weakness with a hedge on financials.
The ProShares UltraShort Financials (SKF) allows you to profit from a decline in the financials, as this fund should appreciate about 2% for every 1% decline in the XLF.
A move to the $22 level appears likely for SKF over the next four to six weeks.
ProShares UltraShort S&P500
Click to Enlarge With the S&P 500 teetering at overhead resistance levels — namely, 1,690 — a hedge on the benchmark index makes sense.
The average investor is able to “short” the market (and then some) by buying the ProShares UltraShort S&P500 (SDS). The SDS fund moves inversely to the S&P 500 at a 2-to-1 ratio, meaning that the fund will go up about 2% for every 1% decline in the S&P 500.
This approach to hedging a lofty market can help to offset potential losses in other areas of your portfolio, which is how the professional money managers hedge their positions ahead of market turmoil.
We’re currently expecting SDS to move to $39 over the next month or so.
iPath S&P 500 VIX Short-Term Futures
Click to Enlarge The CBOE Volatility Index — or the VIX — is known as the market’s “fear gauge.” This barometer of market volatility moves higher as investor anxiety climbs.
Those well-versed in the ways of the VIX know that it tends to spike sharply when the market moves lower. For example, the VIX almost doubled in value from mid-May to mid-June this year as the S&P 500 fell in the wake of Ben Bernanke’s comments on potential “tapering.”
By purchasing the iPath S&P 500 VIX Short-Term Futures (VXX), you can hedge a pullback in the market by profiting from the increase in volatility that is certain to happen when the market declines.
One catch with trading volatility, though, is that when volatility moves, it tends to do so pretty quickly, so this option should only be utilized by more nimble and active traders.
Our current target for the VIX is for a 30% increase over the next month, meaning VXX unites should appreciate by a similar move.
As of this writing, Johnson Research Group did not hold a position in any of the aforementioned securities.