Nasdaq: Here's Why You Need to Hedge Your Stock Investments

Article by Gary Gordon in Nasdaq

Stock market records have a way of enthralling everyone. However, the stock market is not currently reflecting the economy or the corporate backdrop. For example, one may hear that the job market is strong. Yet job growth and job openings are both fading.

One may be told that the consumer is spending. On the other hand, year-over-year retail sales (2.88%) are well below last year (4.58%). In a similar vein, The Bloomberg Consumer Comfort Index fell to a nine-month low of 58. The measure even posted its steepest three-week slide since 2008.

Meanwhile, manufacturing remains mired in an outright slump. The most recent data on industrial production came in at a three and a half year low.

There is a straightforward reason why the Federal Reserve cut its overnight lending rate three consecutive times. It did so because the economy is shaky.

Would Fed committee members be looking to provide monetary stimulus if prospects were wonderful? Keep in mind, the Fed is projecting fourth quarter economic growth at just 0.4%.

Why, then, is the stock market breaking higher? With six straight weeks of upward movement? Massive inflows of central bank liquidity.

Historically speaking, irrational stock market enthusiasm has been a time to reduce risk, not take substantially more of it. The best time to embrace risk with everything you’ve got? When there is panic and hopelessness.

Is this time different? After all, the Fed’s injections of liquidity have trumped the need for corporations to increase their profits. In many instances, profitless corporations without a path to profitability have still seen their shares soar.

The price one pays for bottom line earnings has become irrelevant. What about revenue? The price one pays for corporate sales is as insane as it was during the turn-of-the century stock bubble.

Identifying the pin or pins beforehand is less critical than having a plan for a dangerous downturn. That plan should incorporate hedging one’s exposure to common stock as well as reducing one’s exposure.

The most effective hedges tend to be a combination of the highest quality government bonds and precious metals like gold.

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