There is only one rule in a bubble market ...

by Wayne Ferbert on May 16th, 2013

As a financial services veteran of 20 years, I can attest that you learn a lot of ‘rules’ about the markets along the way. For instance, you learn that for a secular bull market to really get legs, the bears must capitulate and roll over to the bull side to fuel the market higher.
 
The problem with all of the rules that you learn is that they apply to what we would call ‘normal’ markets. I don’t know any analyst that thinks this is a normal market. In a normal market, interest rates are set by the market – and the result is that stocks and fixed income compete for attention from investors.
 
But this is not a normal market. The Fed has artificially forced interest rates near zero and is fueling a market bubble. In a market bubble, many of the normal rules don’t apply. So, through what lens do you examine and analyze the market? It is a difficult proposition.
 
However, a friend reminded me the other day that Bubble markets do have one rule that always applies: All bubbles eventually pop!
 
And this next comment might seem self-serving: since you don’t know when they are going to pop, you make sure you hedge your portfolio. In fact, because it is a timing issue, you must make sure to ladder your hedges. Laddering is when the protective puts that you purchase have different expiration dates.
 
If I were to enter a new hedged position today in the SPY, I would likely ladder using protection from December 2013, March 2014, and June 2014. And you roll the ladder forward as the near date expires. Then, with those regular dates spread out, if the bubble pops sometime, you will have protection at various levels based on how the market moved up.

Remember the rule ...


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