Master Rider Blog

Why You Need a Hedge Strategy

September 10th, 2007 NW Teong

As a frequent reader of my blogs you would have noticed that my current strategy is simply buy and hold some of my first rated stocks (i.e. those stocks with good fundamental, good earnings growth potential, relatively cheap valuation, best of all give me about 3-5% dividend yield) PLUS buying a Put option/warrant of indices. As I said a few times in my earlier blogs, my hedge strategy really provides me with twin objectives. It provides a cushion in case there is a sharp correction or a market melt-down and also provides me with a profit-making opportunity. The very essence of a hedge is basically an insurance feature, it offsets the fall in your overall portfolio. This is crucial especially during this quarter (I have also told you many times before that this quarter is volatile, didn’t I?)

For Singapore investors, to apply a hedge strategy against your portfolio holdings, the best and easy way to do is to buy a Put option or short against the STI index. However, last week, there were glitches in STI index. What to do under such scenario? The next alternative is to do it on few key component stocks such as SGX, UOB, DBS etc. The objective here is using these stocks as a proxy to the whole market. For instance, I have used SGX as a proxy and have actually bought some of SGX Put option (SGX BNP ePW080211) last Friday. If the market rises instead of drop, I will lose money on my SGX Put option but my portfolio would have made me more money. If market falls, than the fall in my portfolio would be offset (to certain extend as mine is not a full hedge) by the gain in my Put option which I may decide to lock in at certain level.

What has happened in the macro level? We know that US markets fell heavily due to a fall in its latest job data. This basically sparks fear that US economy may fall into recession. In short, the sub-prime problem has finally spread to other sectors of the economy. Well, I think while there would be negative impact on other sectors, we should not write a conclusion too early. If we look at those macro data that came out in the last few weeks, they are basically sending mixed signals. To summarise, we have mildly positive ISM manufacturing data for August but have negative data for housing and job market. However, we still have positive data on the consumer markets too. In short, the crystal ball for us to view the future remains slightly blurred at this moment. My read is that US economy would be slowing down with or without the impact of the sub-prime saga. The sub-prime saga could actually expedite the slowdown in economy or alternatively it can actually help to revive the economy. Sound ironical? The logic is simple, if market signals are clear that economy is going into recession, Fed would surely take action by cutting interest rates to prevent a recession. Under this scenario, the immediate response for the stock markets would be very positive. As you may also aware in my earlier blogs, I have said that Fed is likely to cut interest rates even if the market signals are still mixed for what I called a “err on the safe side” strategy. FYI, at this juncture of about 13,113, the down trend of Dow Jones Industrial Index remains intact. If you can recall, I have expressed bearishness on Dow Jones in my past few blogs.

As this juncture, let’s have a quick look at the US 10-year Treasury yield:

Courtesy of Finance Yahoo. 

It had dropped 13 basis points to close at 4.38% which is around the lowest in about two years. This is a clear sign of fight to safety again! Another piece of negative news which most people have kind of immune to it already is the near-historically high crude oil prices. The good news is that the demand for crude oil might come down due to a possible slow down in economy but the bad news is that OPEC is unlikely to boost its production at the moment even at such a high price. This, to me is still a very key factor that weighs on the world economy. What happen if China or/and India economies are also slowing down substantially (not quite likely at this moment)? If this happens, run as fast as you can from the stock markets!

All said and done, this quarter will provide ample opportunities for you to trade. As I have shared in my e-book and e-seminar (The Essence of Stock Investment), we need to investrade carefully. In order to investrade smartly, you need to have the right investment knowledge, acquired the right investment strategies and investment tools, and of course the right mind set. Always investrade prudently and hedge your positions whenever you are not so sure on the big direction. As I have said this many times in my e-publication, we must always have a mind set that tells us that we can never afford to lose money (regardless of how much money we have and whether we can actually afford it or not). Cheers!

Master “The Essence of Stock Investment” and ride towards the journey of your financial freedom! Be the “Master of Your Own Destiny”!

Disclaimer: Investors are investing at your own risk. Please read full disclaimer at the end of the blog or from the main page of the website.

Entry Filed under: Macro, Stocks, Singapore