Investors Need Some Portfolio Insurance Strategies for the Coming Correction

Tony Sagami |

“I would highlight that equity market valuations at this point generally are quite high.”

—Janet Yellen

Are you worried about the stock market? If you are, you’re in the minority of investors.

Greece… China… don’t worry about it!

At least that seems to be Wall Street’s reaction to what could have been a catastrophic fall of dominoes if the European and Chinese governments hadn’t come to the rescue with another massive monetary intervention.

If you think you’ve heard the last about Greece or a Chinese stock market meltdown, you’re in the majority. Investors are pretty darn confident about the stock market.

The John Hancock Investor Sentiment Index hit +29 in the second quarter, the highest reading since the inception of the index in January of 2011.

However, overconfidence is dangerous and often accompanies market tops.

If you listen to the hear-no-evil cheerleaders on Wall Street and CNBC, you might be inclined to think the bull market will last a couple more decades, but we haven’t had a major correction since 2011, and the Nasdaq hit an all-time high last week.

Investors are so enthusiastic that the exuberance is spilling beyond stock certificates to the high-brow world of collectible art.

Investment gamblers are shopping up art in record droves. In the last major art auction, prices for collectible art reached all-time highs, and somebody with more money than brains paid $32.8 million for an Andy Warhol painting of a $1 bill.

Who says a dollar doesn’t buy what it used to?

I’m not saying that a new bear market will start tomorrow morning, but I’m suggesting that bear markets hurt more and last longer than most investors realize.

The reality is that bear markets historically occur about every four and a half to five years, which means we are overdue. And the average loss during a bear market is a whopping 38%. Ouch!

On average, a bear market lasts about two and a half years… but averages can be misleading.

In the 1973-74 bear market, investors had to wait seven and a half years to get back to even. In the 2000-02 bear market, investors didn’t break even until 2007.

Unless you, too, have drunk the Wall Street Kool Aid, you should have some type of emergency back-up plan for the next bear market. There are three basic options:

Option #1: Do nothing, get clobbered, and wait between two and a half and 10 years to get your money back. Most people think they can ride out bear markets, but the reality is that most investors—professional and individual alike—panic and sell when the pain gets too severe.

Option #2: Have some sort of defensive selling strategy in place to avoid the big downturns. That could be some type of simple moving-average selling discipline or a more complex technical analysis. At minimum, I highly recommend the use of stop losses.

Option #3: Buy some portfolio insurance with put options or inverse ETFs. That’s exactly what my Rational Bear subscribers are doing, and I expect those bear market bets to pay off in a big, big way.

Whether it is next week, next month, or next year—a bear market for US stocks is coming, and I hope you’ll have a strategy in place to protect yourself.

If you'd like to hear what worries me most about the stock market, here is a link to an interview I did last week with old friend and market watchdog Gary Halbert.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

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