Granted, not all of the paper-wealth preservers have been hitting their stride. Precious metals like gold and reverse carry trade beneficiaries like the Japanese yen have not seen much interest. Then again, why should they? CBOE S&P 500 Volatility (VIX) at 14 shows little fear of a stock slide. The S&P 500’s technical uptrend remains intact. And the benchmark is only a few percentage points off of an all-time high. In other words, financial assets that have a reputation for working well in bearish markets should not be expected to do well when a bullish rally still exists.
Nevertheless, one should not look to procure earthquake insurance after the ground begins shaking and the walls start tumbling. Three-and-a-half years since the last 10% correction? Seven-and-a-half years since the last bear began to maul? Bull markets may not die of old age, yet the headwinds of a strong dollar, poor earnings prospects, economic weakness and Federal Reserve uncertainty merit the use of non-stock hedges.
What are some of the best performers when stocks struggle? The Swiss franc and the U.S. dollar are currency “faves.” The Japanese yen may seem like an odd choice in light of its country’s 400% debt-to-GDP quandry, yet the world borrows the yen to invest in riskier paper assets. The process has to reverse itself when risky assets are being liquidated and the yen loans are being paid back. Longer-term treasuries, intermediate term munis and Gemran bunds have a long history of success when investors attempt to sell riskier holdings and pursue greater safety. Gold? Same story.
Although many may opt for single-asset hedging of stock risk, I prefer multi-asset stock hedging via the FTSE Custom Multi-Asset Stock Hedge Index (MASH). During the euro-zone crisis (7/7/2011-10/3/2011) – the last hiccup for U.S. equities – the S&P 500 logged a painful -18.8% beat-down. In contrast, MASH garnered 12.4%.
Keep in mind, of course, a multi-asset stock hedging tool may not do be particularly impressive in an unencumbered bull market rally for riskier paper assets. On the other hand, non-stock assets can combine to provide relatively low-risk gains in stock bulls as well. For example, on a year-over-year basis, the S&P 500 is up approximately 12.5% while MASH has picked up about 4%. One would expect those tables to flip over with normal corrective activity. And if we actually witness a bear?