Hedge Your Portfolio With ETFs

THE FINAL NUMBERS - TWO DAY SYNOPSIS NEWS: A 152-point rally yesterday was overshadowed by the 236 pummeling the Dow took today. Through the first three days of the week the Dow is down 1.25% and closed at the lowest level in nearly 2 years. The S&P 500 has lost 1.4% on the week after falling 29 points or 2.3% today. The NASDAQ has continued to hold up better than its peers, down 2.6% today, but only off 0.5% for the week. Within the asset classes, the Mid-Cap stocks are even on the week and only fell 1.4% today.

THE BOTTOMLINE: It is obvious the bears are in control and it will take more than one day of gains to get investors interested in the market again. Today the concern moved back to the financials as both Freddie Mac (FRE) and Fannie Mae (FNM) closed at their lowest levels in at least 15 years. The SPDRS Financial ETF (XLF) fell 5% today after gaining 6.5% yesterday, wiping out nearly all the short-covering gains.

My view on this market is that the negativity is increasing daily as the market internals weaken and the approaches multi-month highs. I expect a capitulation bottom in the near future, fueling at a minimum a short-covering rally that lasts longer than a few hours. However, be careful if you are trying to go long in this market, the bears are clearly in control.

THE DAILY ETF UPDATE - HEDGE STRATEGY

NEWS: A hedging strategy involves using an investment to protect against an event that could hurt the performance of your portfolio. With stocks breaking down and a bear market upon us, there has been a renewed interest in strategies to hedge against further weakness.

THE BOTTOMLINE: The beauty of ETFs is the “short” exposure they can give investors that can create an instant hedging strategy. In lieu of selling a large portion of your ETFs or stocks that remain in long-term uptrend, an investor has the choice of buying short or ultrashort ETFs that will benefit when the index, sector, or commodity it follows moves lower. For example, the ProShares Short S&P 500 ETF (SH) is up 1.2% this week. If you would like to get more bang for your buck and take on the extra risk, there is the ProShares UltraShort S&P 500 ETF (SDS) that gained 2.3% this week. {PFG owns shares of SDS for Money Management Clients.} The UltraShort ETFs from ProShares offer 2-to-1 leverage on the downside. If the S&P 500 loses 2% in one day, the SDS should gain 4% and vice versa. Therefore if you are wrong, you are really wrong!

Let me give you an example to help you understand better. Assume Joe Schmo was invested 80% in the market at the start of 2008, but he was not sure about the market direction and wanted to put a hedge on his portfolio. Joe could have gone out and bought shares of SH with the remaining 20% and the net exposure to the market would have been 60%. Through today’s close the S&P 500 was down 15.2% and Joe would have only been down 9.0%. Without the hedge and 80% in the S&P 500 and 20% cash, Joe would have lost 12.2%.

Assume Joe wanted to take out an even bigger hedge. Instead of buying SH, he bought 20% into SDS (the leveraged short ETF). For the year Joe would have a loss of 6.2%, which is 9% better than the S&P 500 in just over 6 months. Keep in mind this will go against your gains if you are wrong and the market rallies. But, if the hedging strategy makes you feel more comfortable, it could be an option for you.

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