Investing is a journey, not a destination.
You can create your own way of getting where you want to go, but many investors follow tried and true strategies. One such strategy is to grab the coattails of successful fund managers.
After all, the well-known managers are not only wildly successful in their own right, they’re required by SEC regulations to disclose their positions in a timely manner.
This crowd is typically referred to as the “smart money.” These wealthy traders have built huge fortunes for themselves and their followers. These folks get a lot of media airtime, and their words and actions don’t always coincide.
For instance, while Warren Buffett is famously bullish on America in the long term, he typically spends a few years building up massive amounts of cash to make big purchases and opportune moments. Right now, he’s sitting on record levels of cash.
He’s not alone in being more cautious right now. Many top managers are wary of the stock market as it continues to creep to new highs. Bond king Bill Gross recently stated that at today’s prices he doesn’t like bonds or stocks. Carl Icahn sees bubbles forming as a result of perpetually-low interest rates. George Soros has been buying gold stocks and otherwise positioning for a market decline since before June’s Brexit vote.
Admittedly, looking at the situation now, the smart money doesn’t look so smart. They’re either missing out, or are underperforming during a market that yet again hit new highs.
Typically, these folks know well enough not to fight the trend.
But in six months, these investors might look like geniuses. If there’s a sizeable selloff in the markets, they’ll have a better performance than investors who just blindly put all their money into markets at today’s prices.
What makes the “smart” money so smart anyways? It’s likely a willingness to look beyond daily patterns and trends for longer-term clues about the markets.
For instance, market valuation is above average. The median S&P 500 stock trades at 18.2 times earnings. That’s not a huge problem for a growth stock, but most S&P 500 companies aren’t growth stocks. In fact, since 1976, the S&P 500 has only been higher on average 2 percent of the time.
That also comes on the back of declining corporate earnings. With most of the second quarter of 2016 earnings out of the way, we’re on track for a 3.5 percent decline in earnings compared to a year ago. This is the 5th consecutive quarter of declining earnings, and the first year-over-year decline since the financial crisis. Corporate America is doing worse as stocks continue to tick higher.
The decline in earnings means that even if stock prices go nowhere, stock values will trend higher. That’s a yellow flag for the markets. It’s not a red one, at least for now.
So, yes, perhaps the smart money is on to something. But I don’t like to think of it as smart — simply early. While I don’t expect a large market correction in the near future, we are facing a lot of uncertainty coming into the fall.
With that in mind, it would be prudent to follow the advice and the actions of big investors and lighten up on stocks and bonds. While these assets perform well over time, that long-term performance includes some brutal short-term declines. Avoiding the worst of even one bear market can make a huge difference over an investment career.
Rather than add new money to stocks right now, investors might want to add cash. By creating a buy list now of stocks worth owning, and an appropriate price to pay, you can enter a buy order. If there’s a big selloff, it’ll get filled.
Alternatively, for stocks that haven’t followed the broad trend and are still beaten down, investors can sell put options. Rather than wait to buy a company like Apple (AAPL) at $90, investors could sell a $90 put now and receive a premium for taking on the risk of buying shares.
Under this strategy, the longer dated the option, the more premium you can receive. Selling a $90 premium out to October, historically a weak month for the markets, will net you less than $50 per trade right now. That’s not a good enough return relative to the risk over the next two months. But a March 2017 $90 put nets over $200 per contract, a much higher return simply for going out longer.
Of course, selling put options isn’t for everyone. It requires a lot of capital to put to work.
Investors looking to hedge would be better off buying put options. In that space, the best options to buy would be against the broad SPDR S&P 500 ETF (SPY). Put options against the broad index avoids the trouble of trying to cherry-pick in advance what the worst performers will be.
If you’re more concerned about political and monetary uncertainty, like a lot of the smart money players are right now, then consider gold. Whether it’s with the SPDR Gold ETF (GLD) or the VanEck Vectors Gold Miners ETF (GDX), buying call options to bet on further upside is a way to stay long but also benefit from market uncertainty.
The smart money is wary. They didn’t get smart overnight, but from years of studying the markets and making successful trades. Heed their advice. Raise some cash, hedge where you’re comfortable with your gains, and consider some options trades to benefit from increased market uncertainty.
Andrew Packer is a Senior Financial Editor with Newsmax Media. He currently writes the Insider Hotline investment advisory, serves as investment director for the Financial Braintrust, and is managing editor of Financial Intelligence Report. To read more of his work, GO HERE NOW.
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