If you’re a fan of the market tea leaves, you should know by now that several signs are pointing toward a significant correction in equities. And if you believe those signs, you should be looking for a little protection.
Click to Enlarge We’ve got a few ideas about some protection for a correction. But first, let’s take a quick look at the building case for the decline.
One of our “golden rules” of bull markets is that any sustainable rally must be supported by continued speculative interest in stocks (i.e., investors are willing to take some risk to reap rewards).
However, a look at the relationship between the relative strengths of the Russell 2000 — represented by the iShares Russell 2000 Index ETF (IWM) in the chart — and S&P 500 over the last month or so shows the fact that speculators have left this market. Increases in relative strength indicate that the “risk on” trade is on, which is supportive of bull markets. Declines, then, mean speculators are running away from stocks.
This relationship has seen one of its worst decline in more than five years, suggesting that the recent new highs in the broad market are more of a paper tiger than an opportunity for stocks to move higher. According to our charts, a 10% decline could come with some ease, meaning you should be preparing a few hedges to protect your portfolio or even profit from lower prices.
Of course, typically, when people hear the word “hedge,” they tend to think of exotic strategies that are only available to the elite professionals. But that’s not the case. In fact, we have three effective ways to profit or hedge the market that just about anyone can understand and pull off.
Correction Hedges: ProShares Ultrashort S&P 500 ETF (SDS)
Click to Enlarge Want to make money when the S&P 500 goes down? ProShares Ultrashort S&P 500 ETF (SDS) shares are designed to appreciate 2% for every 1% decline in the S&P 500, making it a simple hedge for portfolios.
The current chart suggests two price targets, $30 and then $32.
Correction Hedges: iShares Barclays 20+ Year Treasury Bond ETF (TLT)
Click to Enlarge The decline will trigger another “flight to quality,” which means long-term bonds will catch even more of a bid than they’ve seen lately.
To tackle this, iShares Barclays 20+ Year Treasury Bond ETF (TLT) shares offer an easy way to add long-term treasuries to a portfolio.
As of now, we’re targeting a price of $124 (a 10% increase) for TLT over the intermediate outlook.
Correction Hedges: iPath S&P 500 VIX ST Futures ETN (VXX)
The CBOE Volatility Index (VIX) has been trolling near its one-year lows and is now moving higher as market volatility rises. Meanwhile, VXX shares increase in value as the VIX climbs higher.
Based on the VIX spikes over the last year, we’re targeting a snap higher in the VXX to $40, an 11% profit from current prices.
As of this writing, Johnson Research Group did not hold a position in any of the aforementioned securities.