Santa Claus Rally? Maybe, But Hedge Just In Case

 

Experience is not what happens to a man. It is what a man does with what happens to him.” – Aldous Huxley

 

Wall Street made a nice little recovery on Friday, as positive jobs numbers helped bring the major indices a lot closer to break-even for a week that seemed destined to end up substantially in the red.

Still, in spite of the biggest single-day gains in seven weeks, both the Dow Jones Industrial Index (DJIA) and the S&P 500 Index (SPX) suffered their first losing week in nearly two months.

For the week, the Dow shed 0.4% and the SPX dropped 0.1%. The Nasdaq Composite (COMP) managed to squeak into the black, however, gaining a miniscule 0.1%. More significantly, it ran its winning streak to four weeks in a row and hit highs that haven’t been touched by the tech-laden index since the heady, bubbly days of 2000.

The economic report that sent the market closer towards its recent strong upward trajectory was from the Department of Labor, which announced that November’s unemployment rate was the lowest since the start of 2009.

Of major interest from an investor’s perspective was the fact that the good news on the jobs front was not countered by fears that the Fed would now become emboldened to initiate its tapering of the current bond purchasing program.

The $85 billion per-month program has been credited by a number of economists as a key factor in driving the equity market up to its current record-breaking highs.

This “good-news-is-bad-news” cycle has been in place, to a certain degree, for most of the last several months as investors perceive, correctly or not, that good economic news will provide the Fed with appropriate cover to pull back, or entirely curtail, the current stimulus program.

Maybe it’s the holiday spirit, but in any event, investors seemed to decide en mass to discount the potential impact of the report on the Fed’s decision regarding the tapering timing.

This sentiment may change as next week’s Fed policy meeting draws closer, and therefore becomes more prominent on investor’s radars.

In the meantime, the phenomena of yet another Santa Claus rally seems to once more be rearing its rosy head.

But investors may want to remain diligent, in spite of the tendency to feel merry this time of year, particularly as the market has been having such a bang-up sort of year.

So while “all-alpha, all-the-time” has proven to be a profitable strategy for the bulk of the year, protecting past profits by hedging one’s current bets makes sense, and is hardly a Scrooge-like tendency.

Right now, a good way to protect your portfolio is to add a certain amount of the volatility asset class to the mix.

A volatility hedge provides a certain intrinsic leverage, as it tends to respond particularly sharply during strong market moves. So to a great degree, it can provide a good bang for the buck.

The Chicago Board Options Exchange Market Volatility Index (VIX) serves as a proxy for the whole “market volatility” thing.  The VIX has spent the majority of the last several months hovering around the lower levels of its annual range, which bottomed at 11.70 and reached all the way up to 21, once late June and again as recently as early October.

As of last Friday it stood at 13.79.

In the event of a sharp drop, as could occur should the Fed announce a clear and imminent date for the tapering of its bond-purchase program, the VIX could shoot up 30-40% in a day or two, as is its tendency during swift swings in market sentiment.

You can’t trade the VIX directly, though the purest trade is probably trading the VIX futures. However, as many investors don’t utilize futures in their portfolio, one of several ETFs can serve a similar purpose.

Though there are a number of ETFs that are VIX derivatives; VXX (S&P 500 VIX Short-Term Futures ETN), which tracks the S&P 500 VIX Short-Term Futures Index, remains one of the more useful vehicles for shorter-term hedging.

Add some VXX or another of your preferred VIX-based derivatives to your portfolio this holiday season, and you won’t have to worry about finding coal at the bottom of your stocking.

ETF Periscope

Full disclosure:  The author does not personally hold any of the ETFs mentioned in this week’s “What the Periscope Sees.”

Disclaimer: This newsletter is published solely for informational purposes and is not to be construed as advice or a recommendation to specific individuals. Individuals should take into account their personal financial circumstances in acting on any rankings or stock selections provided by Daniel Sckolnik or Sabrient. Neither Daniel Sckolnik nor Sabrient makes any representations that the techniques used in its rankings or selections will result in or guarantee profits in trading. Trading involves risk, including possible loss of principal and other losses, and past performance is no indication of future results.