Daily Brief - 3 ways to protect your portfolio from a correction (Jan 12, 2022)

The list of things that threaten the bull market in 2022 is long. We stumbled across this nice summary in WSB and we thought we’d just copy it down for you:

Everything is fine

We are not in a bubble. 1000+ PE ratios are sustainable. EV companies with $0 in revenue being worth 150B is normal. Online pictures anybody can copy+paste being sold for millions is fine. Made up internet meme money making millionaires is expected. Real wages going down while stocks go up is perfectly expected for a developed economy. Chinese real estate developers defaulting left and right threatening to tank the No 2 economy wont affect (sic) us in any way.

- GushingGranny1

So what can one do?

Today we’ll discuss three ways to insure your portfolio from shocks in 2022. In the future daily briefs we will go in depth into each solution.

Option 1: Allocate more to Treasuries

Did you know US Treasuries are offering a good entry point?

10-year USTs have fallen 8% in price terms since 2020 - 8% is A LOT(™) in bond space. Similarly, German Bunds have fallen enough that their yield is finally moving close to zero.

Now you might say “But what if inflation…?” and you’d be right to do so.

But if inflation causes a rally in interest rates, (a) equities will fall more than bonds and (b) carry does wonders to recover capital losses in bonds.

Option 2: Look into deep protection each month

Maybe you’re ok to lose some money in a volatile month, but you don’t want to be exposed to a real market crash.

Nobody likes to spend a premium on options, but sometimes it’s the way to sleep better - and there are smarter ways to do it.

For example, did you know that by spending 0.1% of your portfolio each month, you can buy protection against S&P dropping 10-15% over the next 30 days?

A S&P 500 Put with 3925 strike costs you approximately that amount.

Now spending 0.1% each month obviously sums up to 1.2% over a year, but if you’re running a hot portfolio of meme stocks maybe you’d appreciate the long-tail protection from a crash.

If your portfolio is high-risk then you’d need to buy more options because if S&P 500 falls 10%, your portfolio will likely fall - let’s say - twice as much.

This is called beta adjustment and we’ll write more about this topic.

Option 3: Rotate your portfolio

As always, the best protection decision is an investment decision.

Whether you are riding the crest of this bull market with a tech-heavy portfolio or investing prudently in a diversified equity like Equal-Weight S&P 500, you can consider one of several choices:

  • Reduce momentum and meme stocks

  • Increase value stocks

  • Increase alternative stocks like commodities (and crypto!)

  • Move into corporate bonds

And of course going back to Option 1

  • Increase your Government Bond allocation

Again, we’ll write more about this.