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Hedge Me This Batman

By  Jun 26, 2009

Topics: Politics, Finance & Investing

I have now gone into a full defensive hedging posture in my portfolio based on the weakening fundamental and technical conditions of this market. In particular, I have hedged each of my 2011 Call Leaps in stocks such as General Electric and Intel. My only "long only" stocks are a few biotechs that are long-term buy and hold plays largely outside the business cycle.

In the area of fundamentals, "green shoots" have now gone the way of all flesh. What we have now is a largely mixed bag of data out of which it's difficult to forecast a strong economic recovery until at least 2011. The stock market's recent bearish reversal in mid-June reflects the new reality of, at best a weak recovery in 2010, and at worst, stagnation or a double dip.
A little bit of recent history here is worth remembering. In March of 2009, the S&P 500 index reached a bottom and then reeled off a more than 30% gain by the end of May.  However, during the week of June 15th, the S&P dropped about 3%.  Then, on Monday, June 22nd, the S&P gave up another 3% -- suggesting a bearish reversal.
In fact, I'm a bit annoyed at myself for not seeing that reversal coming. Ordinarily, I pay fairly close attention to some international exchange traded funds that serve as an early warning sign for determining the US market trend. Based on a technical analysis, these exchange traded funds were screaming reversal but, being the summertime, and being a bit lulled to sleep by the full market run-up, I got lazy and gave back some of my hard-won gains. That said, you can see the value of using these exchange traded funds in a short video I did for theStreet.com. Click here to watch that video.

As for my hedging strategy, there are couple of things that can happen here. If I am wrong, and we see a resumption of the bullish uptrend, the worst that can happen is that I have preserved the gains I made during the March to May run-up minus the bite that was taken out by the June pullback. However, if I am right, and the market goes down, I can make some money on my puts and cash them out. Then, I still may have the opportunity to profit from my 2011 leaps if the economy does indeed strongly recover by then.
I prefer these possibilities to remaining long in this market and letting all my winners become losers. I also prefer to this hedging strategy to simply cashing out my 2011 Calls because the spreads are such in options that you really take a bath if you cash out in the downtrend. So stay tuned. Let's see how this one pans out.
Short Takes
1. Last week's attempt to deify Fed chairman Ben Bernanke turn my stomach. From the pundits and politicians to sages like Warren Buffett, what all of these Bernanke apologists forget is that whatever steps Bernanke might've taken to "get us out of the mess," Bernanke had a huge role to play in getting us into the mess to begin with. His easy money policies helped fuel a housing bubble at the same time that these policies debased the dollar and killed the European economy and ultimately harmed our export growth. At a critical time, Bernanke ironically was also slow to cut interest rates as the 2007 recession neared.
2. While Bernanke should be fired, there's no way in hell Larry Summers should be his replacement. Any damn fool or defrocked Harvard president can spend his way out of an economic crisis but it takes a calm clear head to resist that siren song and Summers is incapable of that. That's why my vote would go to Martin Feldstein -- Summers' onetime mentor and one of the few people who might be able to lead us back to the promised land of prosperity.
3. To my good friends in pundit land, when you're talking about how the American savings rate is rapidly rising, please remember that the savings rate is a bogus statistic. It only includes wage income. When savings rates were "low" during both the housing and tech bubbles, people were making capital gains hand over fist so that their effective savings rate was actually probably higher.
4. "Cap and Trade" is flat out stupid. If you legitimately want to address the carbon issue, the best way to do it is with a carbon tax that also includes a carbon tax on any goods imported into the United States. By taxing imports into the US, you solve the problem of China and India not wanting to play the global warming solution game.
And yes, any solution to the global warming problem will raise the price of fuel and electricity in every kind of energy we use. If global warming is real, the cost of solving that problem will be a reduction in the income levels and lifestyles of everybody that lives on the planet. Ergo, we have a big decision to make.
Using current economic conditions as an excuse not to make that decision is almost as bad as implementing a "cap and trade policy" that won't reduce emissions and will simply line the pockets of whoever is smart enough to game the system. This is just one more chapter in the "Obama promised us smarter government that seems to be incapable of delivering it" book.