Now is the Time to Hedge Your Portfolio

A few weeks ago, I asked if you believed the current rally was here to stay. At that time, the market had been rallying since the middle of June. Some market participants were calling the June low 'the bottom.'

Time will tell if June was the bottom, but based on what has happened over the last two weeks of August, I am betting that we have not yet seen the bottom.

Let's review quickly what just occurred. The Federal Reserve's President, Jerome Powell, told the country that there would be "some pain" in the coming months. Powell also said that the Fed would "keep at it until the job is done," referring to getting inflation under control.

Powell didn't detail how severe the pain would be or how businesses and households would feel it. Still, I think it is safe to say that Powell acknowledges we are likely heading towards a recession.

The market's reaction to Powell's comments sent the S&P 500 down 9.2% since the August 16 high of 4,327. The NASDAQ is down 11%, while the Dow Jones Industrial Average is off by 8.2% since August 16.

Not only is the NASDAQ down double digits, but the exchange-traded funds that track the major indexes, The SPDR S&P 500 ETF (SPY) and the Invesco NASDAQ QQQ ETF (QQQ), are both now trading below their 50-day averages. That is in addition to them already having given up their 200-day, 100-day, and 20-day moving averages.

Furthermore, economist after economists, jumped on the 'recession is imminent', bandwagon this past week. Most of these economists have even pointed out that the Federal Reserve has miscalculated the intense inflation we are experiencing.

They were referring to when the Fed told us back in the spring that the inflation we were experiencing at that time was "transitory." The Fed was wrong about that, and it is unlikely that the Fed members want to be wrong again by underestimating the persistence of current inflationary causes.

Due to their previous missteps, many believe the Fed will not take its foot off the gas quickly enough. This makes it unlikely the economy will experience a soft landing which we have been hearing about over the past few months.

And if you don't know the opposite of a 'soft landing' in economics, it's a recession.

I believe now is the time to start preparing your portfolio for a long-term move lower. There are a few ways you can do that. The first and most straightforward way is to sell everything you own and get cash. If the market tanks another 10-20%, you will not have to worry. You are in cash.

I am not a huge fan of that strategy since history has proven that it is unlikely you will get back into the market in a meaningful way to take advantage of the rebound, whenever that may occur.

What I propose you do, is hedge your portfolio against a downturn. Don't sell anything you own, but buy some exchange-traded funds that will allow you to profit from a falling market. I detailed several ETFs that you can use to do this a few weeks ago. These products will all increase in value as the markets decline. Therefore if you own one or more of them while the rest of your portfolio is decreasing in value, these ETFs will be gaining value.

I suggest that investors have somewhere between 10-25% of their portfolio hedged when it appears we are heading towards a recession. This hedge will allow you to sleep a little better at night.

It will give you the peace of mind that while your portfolio is losing money, it is not as bad as it could be if you didn't have the hedge. It will also give you the confidence to hold your long-term positions, especially if things get ugly because we all know that selling during those tough times is always the worst time to sell.

As I mentioned, now is the time to start building your hedging position. Start small and slow, but at a minimum, consider what you want to buy and how large of a position you want. The market has not yet completely cracked, so you still have time to put the hedge on.

Matt Thalman Contributor
Follow me on Twitter @mthalman5513

Disclosure: This contributor did not hold a position in any investment mentioned above at the time this blog post was published. This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from for their opinion.