Author: Gary Ashton
Estimated read time: 3 minutes
Publication date: 20th Aug 2019 22:17 GMT+1
Market volatility has picked up in recent weeks and investors are starting to worry that a market correction could be around the corner. In July this year, the US reached a record economic expansion, breaking the previous 120-month record. The stock market has come along for the ride, marking the longest bull market in history, beginning in March 2009. Some investors are worried that the party will have to end at some point but predicting exactly when is the hard part. (For more see, Is It Time to Diversify Away from the US?).
The stock market got a bit of a scare last week when the Dow Jones Industrial Average dipped 800 points in one day when news broke that the US Treasury Yield Curve had inverted with the 10-Year yield falling below the 2-Year yield. Economists believe an inversion tends to be a signal from the bond market that an economic recession will follow. On average, a recession starts about 18 months after the yield curve inverts, but not every time. Anticipating the stock market is even more tricky, with expert analysts saying that markets tend to grind higher in the run-up to a recession.
There are several steps investors can take to hedge their portfolios in anticipation of a downturn in the stock market. One of the most obvious, and probably safest measures, is to convert stock into cash. Holding cash long term can negatively affect your investment returns, something advisors call “cash drag”, but could be a good short-term solution to reduce losses in a market downturn. You will then be able to re-invest the cash later when prices are more favourable.
Gold is also considered to be a haven asset and has rallied hard this year. For example, the SPDR Gold Shares ETF (AMEX: GLD) is up 17.76% this year as investors pile into the asset class. Returns in gold, however, depend on a rising price for the yellow metal, since it pays neither interest nor dividends. (For more see, Why Investors Are Rushing to Gold).
Bonds are another asset class an investor can use to reduce volatility in a portfolio. The number of bond ETFs has exploded in recent years and vary from government to corporate to emerging markets. To move into a safer, less volatile, asset class investors may want to consider the iShares Core U.S. Aggregate Bond ETF (AMEX: AGG). This ETF is up 8.55% in 2019 and has mainly benefited from falling interest rates in anticipation of an economic slowdown.
More aggressive investors may consider things like inverse ETFs or volatility trackers. These investments are not for the fainthearted and have considerable idiosyncratic risks of their own but could outperform in extreme market scenarios. One such ETF is ProShares VIX Mid-Term Futures (AMEX: VIXM). VIX futures are very volatile, and the 8+ year historical track record of this ETF is not good because of the equity bull market. VIXM lost value every year since its 2011 inception, except 2018, when it returned 26.43% because of the market sell-off at the end of the year.
Disclaimer: The writer is an experienced financial consultant who writes for Finscreener.org. The observations he makes are his own and are not intended as investment or trading advice.
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