In recent months, a significant trend has emerged on Wall Street: the capitulation of bearish investors. Despite the stock market showing signs of decline, more and more big-name investors are abandoning their pessimistic outlook and closing their bearish bets.
According to The Wall Street Journal, Goldman Sachs’ hedge fund clients experienced the largest short-covering activity in June and July over the past seven years. This suggests a growing shift in sentiment among investors.
Even Mike Wilson, a Morgan Stanley strategist who has faced criticism for his negative market views, has recently become less bearish. This change of heart is noteworthy considering his previous stance.
Another prominent figure, activist investor Carl Icahn, has also decided to change course. In a letter to Icahn Enterprises investors, he pledged to focus less on hedging stocks to express his bearish views and instead concentrate on what he is best known for: activism.
While some may revel in the struggles of well-known investors, it is important to resist schadenfreude. Especially for those who have found themselves in a favorable position due to luck, it is crucial to recognize the broader market dynamics at play.
This capitulation of bearish investors coincides with a subtle shift in the market narrative. Many investors are growing increasingly concerned about slowing corporate earnings, which could have a negative impact on stocks.
John Stoltzfus, a strategist at Oppenheimer, recently informed clients that S&P 500 companies’ earnings for the second quarter appear weaker than expected. Earnings have declined by 7.8%, surpassing the anticipated 6.4% decrease.
It remains to be seen how this changing sentiment will ultimately shape the trajectory of the stock market. However, these recent developments highlight the importance of monitoring corporate earnings and adjusting investment strategies accordingly.
The Changing Market Narrative: Protecting Your Gains in 2023
As the market landscape undergoes a shift, it is important to assess the current situation. Fitch recently downgraded the U.S. debt rating, while Moody’s downgraded 10 regional banks and issued warnings to others. Additionally, 10-year Treasury yields have exceeded 4%, historically indicating unfavorable conditions for technology stocks. This is due to the adverse impact of higher interest rates on the discounted-cash-flow models used to evaluate stocks.
Compounding these concerns are the financing troubles in the real estate sector and the uncertainty surrounding the possibility of a recession. These factors create a potential recipe for financial indigestion.
If you believe that the market narrative is indeed changing, and you find it premature to jump on the bearish trend, it might be wise to safeguard the extraordinary gains achieved in 2023.
Fortunately, the cost of hedging remains reasonable at this point. The Cboe Volatility Index (VIX) currently remains below its long-term average of 19, indicating relative stability. Michael Schwartz, Oppenheimer’s chief market strategist, recommends purchasing three S&P 500 November $4450 put options for every $1 million in your portfolio as a hedge. According to Schwartz, this investment would offset approximately 95% of any losses if the market were to decline by 10%. (Put options grant holders the right to sell a specified asset at a predetermined price within a specific time frame.)
It is common for most bullish investors to wait until they panic before seeking protection or locking in profits. However, waiting until the end of summer might not be the best strategy. Numerous imminent events could prompt investors to sell their stocks in the coming months. The November expiration provides coverage during key events such as September and October trading months, historically marked by major market declines. Additionally, there will be several meetings held by the Federal Reserve’s rate-setting committee and an abundance of crucial economic data that will offer insights into inflation trends.
One must consider the possibility of stocks rallying throughout the fall, resulting in a loss of the invested funds dedicated to hedging. However, in such a scenario, it is always an option to reevaluate and make new decisions accordingly.
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Steven M. Sears, the esteemed president and chief operating officer of Options Solutions, possesses an exceptional acumen in specialized asset management. With an impressive track record, both he and his firm have garnered substantial recognition in the industry.
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Maintaining utmost professionalism, Steven M. Sears and his firm uphold a strict ethical code. As evidenced by their impartiality, neither Sears nor Options Solutions harbor any bias or vested interests in the options or underlying securities highlighted in this column.