Daniel Bustamante | Coach
It's interesting. Lately I've been speaking with a lot of people (mainly real estate folks) that can sense something is on the horizon in terms of a slow down. Not only them but others with large (+$250,000) investment accounts. Those include, IRA's, 401K's etc. that are concerned up at these highs. I want to address a few things in this blog:
1. How to make money betting against the market
2. Portfolio philosophy
If you're reading this or if you're like a few people I knew that have had hour long phone calls with me trying to piece it all together then congratulate yourself. You're looking forward and preparing and that's what most should do. Just like you, I do the same, it takes time, running scenarios and ideas to formulate a plan of attack. I don't claim to have some special investing prowess or even to be the best investor (hopefully in 20 years I will look back and do well) but I think I have a good 'traders feel' and basic understanding of how to use the right products to make returns.
How to Make Money in a Bear Market:
So before I start on this, I don't want to say I am calling a market top, I'm not. That's almost impossible to do anymore with algorithmic trading stopping most large sell-offs like we saw in the late 80's and 2000's. What I am saying though is around these highs that it's hard to allocate capital to stocks. And for the record, I said the same thing in 2014 when I was a portfolio manager at a long/short fund in Scottsdale. For Q2 I struggled finding 'long ideas' and I sat in cash for most of it. It was annoying.
However, I am a big believer in keeping it simple. Where the markets are now, it's dangerous to be buying new net long positions. What I mean is if you're reinvesting dividends I would consider stopping. Most financial advisors are going to tell you not to, but consider the conflict of interest in all of this, it's there. But, let's get on to how to make money betting against stocks.
Short Index ETF's
Most retail investors are not saavy to short stocks outright (you can learn, and if you're serious I would suggest it) so ETF's allow you to buy shares of an index and when that index falls, profit. That's the great thing about capital markets; There are many vehicles to express an investment theory, half the battle is finding that vehicle that works. The ones I like are here.
These usually are the 'easiest' way to bet that the market indices will go down and there are no fees associated with them.
Another one that I like is QID. This will bet against the Nasdaq price falling. I really agree with this as an overall theme.
There are a few more but for sake of keeping it simple in this blog let's just stick to those.
Short Index Futures
Index futures are a great way to short (bet against) the market falling and there are tax benefits. I'll warn you however, most retail traders won't be able to handle using these products mainly because of the leverage involved. But, if you can then they are a great way to also allocate money to betting against the market selling off. Also, you don't need hundreds of thousands to do it either, which is great, and allows you to keep cash on the sidelines (discussed later).
Long Dated Index ETF Put Options
The Index ETF's are a great way to bet that the market is going higher, but, we think we're going lower soon. So, you can use the underlying options on those ETF"s to bet against the market. ETF"s like SPY, QQQ, IWM are my favorites. Those instruments have options chains that have a lot of liquidity which means you can easily execute a $50,000 put options order buying and selling (for the most part).
With this, one could buy long dated (12-24 month) put options. The risk is capped, you don't have to watch it everyday and you can allocate a small percentage of your portfolio to this trade. This gives you market exposure to the short-side at a fraction of the cost.
Short Individual Stocks
This one is a bit more complicated and takes a little more skill. I only mention it here because it's something I would be doing in the event of a market turn, which I believe, we are close too. The issue as I see it is that it get's a little more complicated and the risk here is a bit higher for other reasons. Now finding those stocks to short is a tedious task whereas using the ideas above is pretty simple.
Short Market Cocktail
In a perfect portfolio structure I would look at what I would call a 'Short Market Cocktail' but hopefully one that let's you avoid the morning hangover. This would look something like this:
40% capital allocation to Short Index ETF's - Buying the actual shares here.
20% capital allocation to Short Index Futures - Nasdaq futures primarily.
15% capital allocation to Long Index ETF Put options.
10% capital allocation to Short Individual Stocks.
15% capital allocation in a cash position for short-term trading opportunities. (there are always plenty of those)
So what you notice here is there are no 'long stocks' meaning nothing that I would be holding assuming that it is going higher (Short Index ETF's excluded).
Why is that? We're going to get to that in part two below.
So we've talked about how to potentially make money when markets sell off so let's discuss some philosophy behind it. Again, everyone has their own and I'm not saying mine is better or worse, but sharing.
Let's start with this current bull-market run we've been on. It's the longest in stock market history. There are opinions as to why that is but looking back is usually a waste of time so let's just all agree that it's good. Making money on the long side (buying) has been, or should have been, relatively easy the last 6-9 years. I say 'easy' because I sold BABA way back when and look where it is now. Which makes the case for the question, well what if we just keep going higher?
Yea. That can happen too. But I want you to consider what I do as a 'trader' (and usually that comes with a bad name - but traders have 'market feel') and look at the overall market. As I look at the Nasdaq, S&P500 and leading FANG stocks I notice a lack of 'thrust' or buying the last two months. Major names like Priceline, GOOGLE and even NetFlix are missing those large 1-2 day rallies. I remember 2009 well and I remember what market turns look like from 12 years of doing this and I can tell you that looking at those items tells me we're in for a turn here soon. How much? Who knows, I won't even pretend to be that smart, but I know a reversal when I see one and we're getting close. (For the record, and this counts for nothing, I mentioned that we were in for a pullback at Financial Fest in Scottsdale in January, then February we had that nasty sell off). I said the same thing as I said above.
To continue on this idea of a market turning. I had a friend of mine in Hong Kong who is a 30 + year analyst whom I share ideas with send me some charts on margin lending.
You can click that link to expand it.
If it doesn't make sense, don't worry, it's a little more complicated and it's not something you're going to find the YouTube and Twitter Gurus discussing as they sell you the $29.99 magical indicator.
The article he sent me explains it much better than I can so I am just going to link that here.
So when I say that the markets are at, what I believe, to be a turning point I think you have to look at that and say maybe it's time to 'take some off the table' or even take, say 40% off. Realize the cash/profits. There's nothing wrong with that. And if we're being really transparent here the markets need people to not take money off the table so that the other sides can win and the markets can function as they do.
Second portfolio philosophy now. You don't need to be 100% or even 150% (margin as the chart above shows) invested at all times. I know some hedge funds use special levered funds to enhance returns and I'm not against it, and should I get the chance, will at some point likely use that as a tool as well, just not at the current time. So by that being said I think the art of individual stock selection is an approach many investors can take.
Let me give you an example I gave a friend of mine just today on this. He has about $1.5 million in his portfolio. So I asked how much were you up this year and he goes about $200,000, through the use of mutual funds mostly. So on a percent return basis that's what, 13%. That's good. But, what I explained is that you had to have $1.3 million fully invested at the start of the year to return that.
What I tried to explain was what if you selected 2-4 stocks and used $750,000 in capital allocation on those stocks and kept the other in cash or say maybe a REIT or high paying dividend stock. What if one of those stocks was Square which is up massive this year? What if he had 10% of his portfolio ( I believe in this, diversification is a myth - up to a certain dollar amount that is) or $120,000 allocated to Square? He would be up nearly $90,000 let's say alone from that.
So I say that individual stock selection is key and much better than the lazy approach of just putting money into mutual funds and checking your statements once every 6 months. Now this all may sound simple and easy but finding the right stocks is hard, no question about that however, it can be done.
Now the other cash on the sidelines that's not invested? So what. Let it sit is what I say until an opportunity comes knocking, especially at these all-time market highs.
So I hope this blog, while longer than other ones, brings a little value and insights to your investing. Hopefully it let's you know that all investors 'experienced' or beginner go through the same analysis process and are on the constant quest to find the perfect method to allocate and manage risk in the markets.