Market Observations from Buy & Hedge

by Wayne Ferbert on September 25th, 2012

Mr. Market can’t seem to make up his mind lately – which makes me wonder if he is a Mr. at all. Sorry, I know that is cheap gender humor. But I want to be able to laugh while looking at a market that sends so many conflicting signals.
Jobs growth has slowed to terribly low levels. GDP growth is nominal. But US Corporate earnings are at record highs. Today we learned than home prices are up again. With the market run of the last 12 months, most Americans in the market probably feel a little more wealthy than they did at this time last year.
But many ‘grass roots’ measurements like job growth and consumer sentiment are still showing weak measurements. The conflict is natural: how can companies be making great profits and markets be so optimistic when the ‘straw that stirs the drink’ (ie, the consumer) is hurting so much. It is a lot to digest and consider when investing.
Regardless of how we digest it, Mr. Market just keeps wanting to go up – but in small increments lately. The climb has been steadier than we saw in 4th quarter of 2011 or the 1st quarter of 2012. There are fewer +1% or +2% days up in the market. It has just been mostly a steady climb upward.
We prefer the steady market climbs at Buy & Hedge. These climbs cause the hedges to lose value slowly and our covered calls are more likely to expire worthless.
But the slowing pace of market increase could be a sign that the market high is near. There is a concept in math called an inflection point. It is the point where the acceleration of an object or measurement begins to decrease. In other words, you are still increasing but the rate of increase is declining.
The value of Mr. Market is not a perfect test case for using inflection points because the Market indices are a collection of individual metrics. However, the technical traders will tell you that the market increases slowing is a bearish signal. Technical traders look at momentum and acceleration all the time.
At Buy & Hedge, we are typically always long the market. We don’t try to time the market – because we don’t need to time it when we are hedged. However, our view of the market affects two maintenance transactions we must consider: (1) re-setting our expiring hedges; and (2) harvesting our gains.
If you believe that the market run is getting ‘long in the tooth’, then you will re-set your hedge levels when they expire to much higher levels than you might traditionally. You would effectively be looking for tighter ‘stops’ in the event the market declines. We recommend only doing this when your protections are naturally expiring - not any earlier. But the September expiration that just occurred probably is providing that opportunity as the quarter ends are popular for use by Buy & Hedge investors.
If you have some positions that have had nice runs and believe that the upward potential of those positions is now limited, then you would look to harvest those gains. We rarely make that call on the broad market index. But you might have a sector index or specific stock position that you feel that way about.
If so, we recommend taking the gain – and look to sell OTM puts at a new lower level that will make you an owner of it again if the stock or ETF drops lower again.

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