Crash Alert: How Smart Investors Hedged in February 2018
In February 2018, we warned of impending downside.
And downside we got.
Shortly after the warning, the Dow would plunge more than 1,000 points before a slight recovery to 25,800. But thanks to fears of a trade war, the Dow again plunged another 1,000 points.
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Granted, the underlying economy was quite strong at the time.
Private companies just added another 241,000 jobs in March 2018, as employment in construction and manufacturing skyrocketed. That was well ahead of estimates for growth of 205,000 jobs, and marked the fifth straight months that private payrolls topped 200,000.
And many strongly felt the good times would just continue.
Unfortunately, not many were prepared for the chaos that ensued. Sure, we may not have a crystal ball, but the idea of leaving a portfolio unprotected never made much sense.
In short, our message was clear. Always protect your money even if the market is flying higher.
Around the time of the warning, we offered the following suggestions:
Trick No. 1 – Hedge your Bets
Trade the potential for Volatility by buying Volatility Index (VIX) calls, we noted.
Buy a put option on the NASDAQ, the DIA or even the SPY.
We can even hedge our long positions with ETFs, as well, including the Pro Shares Short S&P 500 ETF (SH), the Pro Shares Ultra Short S&P 500 (SDS) and even the Pro Shares Short Russell 2000 (RWM). All did quite well.
Trick No. 2 - Have Cash on Hand
Some people think it’s bad to have cash laying around, an “unproductive asset that acts as a drag on such markers as return on equity.”
But that’s not the case for Buffett.
“Cash, though, is to a business as oxygen is to an individual: never thought about when it is present, the only thing in mind when it is absent,” he says.
At the end of 2017, Berkshire Hathaway had $116 billion in cash. With that much money, he could buy any company within reach.
But he didn’t.
Even though his company’s role is to buyout companies and bring them under the tent, if you will, he didn't buy much. And that’s because they were all overpriced.
Think about that.
One of the richest people in the world with company sitting on $116 billion in cash did nothing, but sit on it. He was protecting his company’s money by not spending it. What he was doing was protecting his money from a potential decline.
It doesn’t matter how appealing an asset may appear, if it’s also overvalued, it’s better to protect yourself by hoarding cash.
Trick No. 3 – Don’t Follow the Herd
One of the key reasons that many investors underperform in the market is because they move in and out of assets at the wrong time. When an investor sees everyone else making money from rising markets, that's when they tend to throw every spare dollar into their investments.
In short, they get caught up in herd mentality.
Trick No. 4– Be in a Strong Position to Capitalize
Buffett once said:
"Too-big-to-fail is not a fallback position at Berkshire. Instead, we will always arrange our affairs so that any requirements for cash we may conceivably have will be dwarfed by our own liquidity."
Buffett went on to point out that during the financial crisis, Berkshire was a buyer when others were panicking.
He sells when others are greedy; and buys when others are fearful.
With cash on hand, Buffett has the financial flexibility to jump on opportunities that popped up. As the billionaire often points out, keeping some cash on hand allows you to take advantage of corrections without having to sell other investments.
In short, buy low, sell high in a crisis situation.
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