Summertime Hedges

By Aaron Levitt | June 13, 2011 AAA

There's an old Wall Street adage "sell in May and go away." Normally during the summer months, stocks tend to drift lower as institutional investors take summer vacations. This year, the continuing problems facing the European Union's sovereign debt, slowing economic growth in the U.S. and the impending end to the Federal Reserve's quantitative easing programs are all exacerbating the effect. It's no wonder why the SPDR Dow Jones Industrial Average (NYSE:DIA) is down nearly 5% since June began. Stocks overall have experienced nearly six weeks worth of losses. With the immediate-term economic outlook dour, many investors are in a quandary about what to do. While it's too late to sell in May, there are plenty of ways for investors to add an insurance policy for the rest of summer.
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Uncertainty Abounds
Going into summer, the global economy has been hit by a wave of bad news on all fronts. Internationally, Greece debt woes have once again brought the eurozone's debt crisis back into the forefront of investors' minds. The PIIG nations continue to be a thorn in the side of Europe and will require constant handholding. In the emerging world, food price inflation is becoming a serious problem and has the potential unhinge the developing world's strong growth prospects.

Domestically, the United State's problems are persisting. Unemployment remains high and the lack of jobs is hurting consumer confidence. For the month of May, the index dropped by 5.2 points, reaching a six month low. The Conference Board stressed in its report that consumers remain overly pessimistic about the labor markets for the next six months. Housing also remains a point of uncertainty, with the latest Case-Shiller home price index declining 3.6% year over year. The housing market has now doubled-dipped and reached a second bottom.

With all the headwinds facing the global economy, it's no wonder why the major stock indexes have fallen over the last few weeks. There are real worries out there. However, just as a homeowner who lives in a flood plain takes out insurance against such an event, adding a portfolio hedge or two would help many investors sleep better at night. With the recent exchanged-traded products boom, retail investors have gained access to sophisticated tools to help protect their portfolios from large market downturns. By adding one or more of these portfolio hedges, investors can rest more soundly over the summer.

Precious Metals
It's probably beating a dead horse at this point, but investors need some exposure to precious metals. Gold, silver, platinum and palladium all have historically acted as hedge against both uncertainty and inflation. The ETFS Physical Precious Metal Basket (Nasdaq:GLTR) holds gold, silver, platinum and palladium. This gives investors easy access to not only the hot gold market, but also the industrial demand for silver and palladium. For those just wanting gold's safety net status, the SPDR Gold Shares (NYSE:GLD) is still the largest fund in the sector.

Option Income
At its simplest form, a buy-write option strategy is where an investor buys a basket of stocks tied to an index and writes call options that cover the stock position. The income generated from the option helps cushion sideways and downward movements in the index or stock price. The PowerShares S&P 500 BuyWrite (NYSE:PBP) and iPath CBOE S&P 500 BuyWrite Index ETN (NYSE:BWV) offer investors a chance to use the strategy without actually writing the call options. Similarly, adding a dividend focused fund like the SPDR S&P Dividend (NYSE:SDY) could help cushion losses.

Safe Haven Currencies
Despite its own set of economic headwinds, the Japanese Yen is seen as strong safe haven currency. The same can be said for the steady Swiss Franc. Investors can add both these currencies to a portfolio via the CurrencyShares Swiss Franc Trust (NYSE:FXF) and CurrencyShares Japanese Yen Trust (NYSE:FXY).

Bottom Line
With the summer doldrums approaching and the uncertainty facing the stock market, investors could use a hedge. The preceding funds along with inverse or short ETFs like the ProShares Short Dow30 (NYSE:DOG) or Direxion Daily Developed Markets Bear 3X Shares (NYSE:DPK) make ideal insurance candidates for a portfolio. (For related reading, also take a look at Dangers Of A Double Dip Recession.)

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