Editor's note: This newsletter was intended to be published on Friday morning, May 31.
In yesterday's note, I did caution about headline risk. With 20/20 hindsight I wish I gave it more prominence than just one sentence. This series is in no way political; we are firmly focused on stocks, stocks of companies of the good ole USA, traded right here in America. Joshing aside, politics have to really be disruptive in order for markets (and us) to sit up and take notice. A call for tariffs in order to pressure Mexico to tighten the border would normally be concerning for the economy. In this case, it's especially impactful due to the new NAFTA deal, or, as the Trump admin calls it, the USMCA was about to close. Will it now? No one can say for sure. So yes this is a code red, sit up and take notice. In general, markets don't like surprises and no one was expecting further tariffs against Mexico after it was just announced that the U.S. was rescinding steel and aluminum tariffs to clear the way for USMCA. So what does this mean for us, the beleaguered traders? Just look at the 10-year, a major indicator for market sentiment right now. We are headed below 2%, and that is a number even Ma and Pa Kettle will take notice. Newsweek and Time will cover it, I think. Fear will win over greed today, and who knows what happens over the weekend.
Get ready for the Greek Chorus and Nattering Nabobs of Doom to Take Center Stage
The slide will accelerate as predicted to the next support level, 2750 and it's nearly a given that we will see the 2600 handle on the S&P in the next few weeks. At that level, the S&P will be trading at 15 times 2019 earnings, with inflation below 2%, we have to start buying in earnest. Once we break 2700 you will hear more strident claims for a recession in 2020. Remember that? You will hear calls for the S&P dropping all the way to 2350-2400 harking back to December. Keep your ears peeled for this rhetoric as that will be the bottom. I was hoping for a counter-trend pop starting yesterday; perhaps we'll see it next week. What else to watch? Keep an eye on the VIX, all this week it was below 20, hanging out around 17. That says to me that even with this sell-off market participants were not panic hedging this week. We want to see that in order for there to be a tradeable bounce. The chances have now gone up for some sloppy market behavior. Also, the bear prognosticator professionals will wag their fingers and tongues. Once we hear the equivalent of nuclear winter that will be the sign that the storm is over.
A Good Time To Talk About Hedging. Let's Just Call It Insurance.
I really don't feel okay talking buying stocks without being more prepared for the downside. Step back, don't try to catch any falling knives. Let's talk about protecting the portfolio of stocks you already have. Hedging is an intimidating word so let's call it "insurance." I don't recommend shorting stocks like I don't recommend trading on margin, but there are ways to hedge without shorting. The best way to get protection is to write calls against your stocks. Selling ("writing") calls means you are selling the right to sell your stock (but not the obligation) at a particular price (the strike). An options contract represents 100 shares of equity, so keep that in mind. Writing a call means that you have 100 shares to call away if the stock rises above the strike price. This actually is a very conservative way to get "insurance." Obviously, the timing would have been much better to write calls when the S&P was at 2950. You might want to get in the habit of selling (writing) calls against positions on a monthly basis to create a revenue stream that some call artificial dividends. The downside is if your stocks get called away it might create a taxable event. You may want to get even more aggressive (perhaps during times like this) to use the funds generated by writing calls to buy puts. Remember that you are being paid for writing calls so funding put buying could potentially be free. So just to tie this off, when you write a call the other side of the transaction is buying it from you. If your stock does not get called away you get to keep the premium as income. If you are more concerned about the market than usual you can use that income to fund buying puts to more aggressively insure your current portfolio. You can buy puts against the indexes, or against any stock you feel will go down with the market or for any reason. You can also buy puts against your individual positions as well. Finally, when a stock gets "called away," you will be paid the strike price you sold the call at. So if you sold calls against your position of AMZN at a 1900 strike and AMZN rises above that strike you will be paid 1900 no matter how much higher AMZN goes. Since you also get to keep the premium you sold the call for chances are you still come out ahead. I am only talking about using options in a way that is even more conservative than just buying and holding, watching your portfolio go into the red and feeling helpless. I am not advising you to use Options in a more aggressive way.
Every Discount Broker HaS Webinars on Options
Educate yourself and reap the benefit. Most people would be intimidated by what I described above and if it was any easier the benefits to those that master this would be less. Go to your trading site and there will be a link for education, look for options trading specifically for writing calls to start. Don't be shy, call customer support and ask for the instruction videos on "Writing Covered Calls." Some discount brokers will have "Coaches" to help you. Ask customer support if they have that. Again focus on the conservative capability of options.
Now I Feel OK to Talk About Stocks
Just this week and for the first time in 2019 a General Electric (NYSE:GE) insider bought 10,000 shares. I think this should give us the courage to get longer in GE. You'll notice that in all this gloominess GE has held up really well. Boeing (NYSE:BA) has also been holding up pretty well against this backdrop of China trade. China is the biggest buyer of commercial airliners and Boeing is the only player with the capacity to handle that need. Airbus has less flexibility to raise production.
Mortgages Have Fallen Below 4% for the First Time in a Long While
We should be looking at housing and even sales and refinance. I would go long Zillow (NASDAQ:Z), Redfin (NASDAQ:RDFN), and Lending Tree (NASDAQ:TREE). I would look at the builders KB Home (NYSE:KBH), Lennar (NYSE:LEN), Toll Brothers (NYSE:TOL), LGI Homes (NASDAQ:LGIH), DR Horton (NYSE:DHI), and Pulte (NYSE:PHM). Mortgages should stay this low for the foreseeable future; housing should remain comparatively strong. This is a good time to give an update on Freddie and Fanny Mae (OTCQB:FMCC) and (OTCQB:FNAM). There is chatter going on that they will be allowed to recapitalize. Really long time readers will have every right to roll their eyes. However, these names throw off prodigious cash which the Federal government is just sweeping into its own pocket. I won't go into the saga here, but if they are finally set free both of these names will be powerhouse dividend gushers. It's time once again to speculate that the government do the right thing. Go long but please don't overdo it. This is highly speculative and tied to breaking the DC logjam. The good news is that you have the whole weekend to study up on these names. No one needs to buy today.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.