How to Play Q4 Defense: Hedge Your Bets, Up Your Stops and Sell Your Gold

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So far fourth quarter earnings have made a mockery of things.

Of the 20 S&P 500 companies that have provided Q4 guidance so far, 18 of them have guided lower, "slashing" their forecasts, according to Goldman Sachs and CNBC (as of Monday afternoon).

What's more, roughly one quarter of the reported earnings have come in flat to middling. According to Capital IQ, overall revenues are up only slightly at 0.34%.

Yet, for some reason the S&P 500 is only 3.89% off of its highs and is up 12.01% year-to-date through Wednesday afternoon.

Under the circumstances this suggests two things to me:

  • There's a lot of volatility waiting in the wings; and,
  • The near-term risk is to the downside.

First, let's tackle the volatility that's still in store; then we'll move on to what you can do to prepare for it.

The Q4 Earnings Story

So far this earnings season, roughly one quarter of the S&P 500 has already reported. That leaves the market with nearly 375 companies that have yet to spit out their numbers, roughly 150 alone this week.

Assuming the balance follows the pattern set so far, companies like Caterpillar Inc. (NYSE: CAT), Philip Morris International (NYSE: PM), and 3M Co. (NYSE: MMM) are going to show "respectable" (under the circumstances) numbers while talking about the "challenges" they see ahead.

Meanwhile, a few others, like DuPont (NYSE: DD) and United Technologies (NYSE: UTX), are going to reflect weakening earnings and revenue pressures leading to further cost-cutting as a means of protecting profits. These will include job cuts.

I also expect the bulk of the remaining companies will take the opportunity to lower their expectations — especially when you consider that 61% of the companies as of Monday afternoon missed revenue expectations.

The irony here is that 61% of the companies that have reported over the same period have also exceeded analysts' expectations.

Naturally the markets will punish those who missed even when what they should recognize is that the analysts were wrong yet again. But that's another story for another time.

What's important to understand is that top-tier company management is using this earnings season to accomplish three things.

First, they're telegraphing real worries from the C-suite. Despite what the Fed wants us to believe, executives remain cautious and uncertain. So they are hoarding cash, hiring only when necessary and trimming things to the bone.

Second, they're lowering the expectations bar to the point where any hint of prowess in the future will likely induce an earnings "surprise" and engender additional support for their share prices.

Three, they hope investors will respond to both situations favorably and they're banking on Fed policy as the primer. There's no question the Fed has run out of bullets given the near-complete lack of response in the markets to QE infinity. And with the fiscal cliff approaching, they'd like to appear protective rather than aggressive, figuring it's the easier position to defend.

Now let's talk about the downside.

If you look at a chart below of the S&P 500, the range-bound conditions we've seen since this crisis began are evident. So are the much broader ranges since 2000, which is really where this mess started from a technical standpoint.

Chart: Fitz-Gerald Research Publications, Yahoo Finance

Put that against Professor Robert Shiller's work, and you can see the Fed is clearly trying to engineer a rally even when the natural proclivity is to guide lower to the norms established since the end of WWII.

At 17.7 times earnings, the S&P 500 is still expensive in the big scheme of things.

http://www.ritholtz.com/blog/wp-content/uploads/2012/10/BF-AD687_UPSIDE_NS_20121019171504.jpg

Figure 1: Wall Street Journal, Robert Shiller – Yale University

This isn't a surprise. Or, at least it shouldn't be.

As my good friend Barry Ritholtz, CEO of Fusion IQ, recently pointed out so eloquently in his blog, The Big Picture, the "Fed's liquidity fire hose has forced managers into equities beyond what is normally prudent."

That's the key: normally prudent. There's nothing normally prudent about anything the Fed is doing at the moment.

Sell Your Gold??

And that brings me to what you can do about all of this brewing volatility…prudently…and ahead of time:

  • Hedge your bets by either shorting stocks or picking up shares of my favorite inverse fund, the Rydex Inverse S&P 500 Fund (RYURX), or tapping into an inverse ETF like ProShares Short S&P500 (NYSEArca: SH). Michael Purves, who is the Chief Global Strategist for Weeden & Co, made the case for shorting small caps as an alternative on CNBC, recently noting that the higher financial leverage and lower yields offer better opportunity. I agree, but only if you can stomach the additional risk.
  • Be ready to sell your gold then buy it back again at a lower price. Don't I mean buy gold then get ready to sell it? Nope. Not this time. Many hedge funds and institutions are using gold to collateralize their marginable assets right now so one of the first things they're going to sell to raise cash when faced with a margin call is gold. They're also sitting on large profits that they'll immediately begin to take off the table in a sell-off. This will end up catching a lot of investors by surprise because they expect gold to take off when the stuff hits the fan. It will…but only after it takes an initial hit.
  • Ratchet up your trailing stops. The markets have risen significantly since the beginning of the year. If you're using your trailing stops properly (and I hope you are given how frequently we've talked about them), that means you should be moving up your stops in near lock step. Or, consider buying put options as an alternative. The last thing you want to do is let a big gainer turn into a loser if things roll over.

And as always, remember that buy-and-hold is a marketing gimmick, not an investment strategy.

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About the Author

Keith Fitz-Gerald has been the Chief Investment Strategist for the Money Morning team since 2007. He's a seasoned market analyst with decades of experience, and a highly accurate track record. Keith regularly travels the world in search of investment opportunities others don't yet see or understand. In addition to heading The Money Map Report, Keith runs The Geiger Index, a reliable, emotion-free guide to making big money and avoiding losses, and Strike Force, which aims to get in, target gains, and get out clean. In his weekly Total Wealth, Keith has broken down his 30-plus years of success into three parts: Trends, Risk Assessment, and Tactics – meaning the exact techniques for making money. Sign up is free at totalwealthresearch.com.

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  1. Paul G Huber | October 25, 2012

    Keith

    Sell my gold? We disagree. Gold is too volital to be out. My view is that Gold is now on sale.

    • Keith Fitz-Gerald | November 5, 2012

      Hi Paul.

      Thanks for writing in.

      In the longer scheme of things, I agree…gold is on sale. While my forecast is moving around a bit as central banking liquidity changes, I still expect north of $2,000 an ounce; what I am talking about here really is a much shorter tactical unloading that will happen if traders get spooked and have to perfect their collateral.

      Best regards for a great day.

      Keith

      • Raptorfire | January 14, 2014

        Can't happen Keith! Any gold per ounce that breaks 1650 per unit crashes the economy its in. Do some research, no economy can hold it up. Don't be a fool.

  2. Thomas Davis | October 25, 2012

    Greetings Keith,

    Re: Be ready to sell your gold then buy it back again at a lower price.

    Will this apply to Silver stocks and ETF's as well?

  3. Money May | October 25, 2012

    Keith, I am heavy in Silver, does this apply to Silver as well and what type of drop are we looking at? I'm not one to chase after things and don't mind holding on to my precious metals if we are only talking about a 10-20% pull back. I'll just buy more at the lower price vs. selling my holdings. Can you give us more info?

    • Keith Fitz-Gerald | November 5, 2012

      Howdy Thomas and Money May (I'm an old Rod Stewart fan so I can't help but want to type Maggie May)…

      In response to your questions, that's a tough one. Silver has very different characteristics. While it's come to be more closely traded like gold in recent years, the relationships aren't as clear.

      My expectations at this stage of the game are that silver will take a hit but that it will not be as substantial for two reasons: 1) there's still a lot of industrial demand that helps buoy prices; and, 2) central banks don't yet seem to accumulating it with the same intensity as they are gold….yet.

      Thanks for taking the time to ask.

      Best regards,

      Keith

    • Raptorfire | January 14, 2014

      Silver, interesting should be good for a buy for the next 16 years since 88% of it is already claimed as its mined. Sony wants it for PS 5, 6, 7 big for super computers. After 16 years PUNCH OUT!

  4. Horst schinagl | October 25, 2012

    Hi Keith, what do you think will be the impact of Basel III after Jan 01/2013? Will banks just be happy with the 50% revaluation of their gold holdings? Or will they buy more because of that, or even reduce their holdings .. Could have quite an impact on gold prices?!

    • H. Craig Bradley | October 26, 2012

      I asked Keith in person in Beaverton, Oregon in 2004 if he had an thoughts about the influence of Basil II Accords on markets or finance and he said he really did not know.

  5. fallingman | October 25, 2012

    Look, there's no question that the metals are vulnerable to a smackdown if the general market gets whacked, as it should. The liquidity concern is valid. This is exactly what happened in '08. And, of course silver will get whacked if gold does. These are legitimiate concerns. And one never knows how far down is down and how far up the next rally may take us, but if the eventual destination is a lot higher, which I firmly believe it is, you'd better be careful trading out in hopes of buying back in.

    Here's the key consideration. Are you a trader or are you holding for the long term? What you don't want to do is sell out of core positions you hold in anticipation of big upmoves ahead for the simple reason that you may never buy back in. Human psychology is tricky and markets can move fast.

    So, say you sell and gold goes down $60. Is that enough? How about $100? What if it goes down $40…or it just barely pierces $1,700 and then starts to grind it's way higher. Do you buy back in? When? When it breaks above $1,810? Hard to know, especially with markets this manipulated.

    My advice, for what it's worth, is to not touch the core and take any short term lumps you're gonna take. Sell out of the money calls against your positions or buy some puts if you're really worried, but don't sell something you may not buy back.

    Personally, while I also think a further knockdown is coming, I don't know that it'll be all that big. I think metals investors are fighting the last war and there's actually a very strong bid by extremely cashed up players…China and other central banks and big money players…not far below current prices. They're accumulating on selloffs, like real professionals would who want to build large positions. But hey, I'm guessing. That's all any forecast is…a guess, however well educated. Don't give anybody's near term trading advice too much weight. My advice, for what it's worth, is to be long and strong. Trade around the edges of a position and buy protection if you like, but don't touch the core! You could easily be looking back from $3,500 asking yourself why you ever sold.

    • Keith Fitz-Gerald | November 5, 2012

      Well said Fallingman. The best traders and investors almost always build around core positions by selling into strength and buying into weakness. And, depending on their expectations, they may have varied time horizons so one person's short term is another's long term or vice versa. Keith

  6. H. Craig Bradley | October 25, 2012

    I think if you bought quality dividend payers in 1985 and held them, then your cost basis is so low you can not afford not to hold them. Just collect the dividends and forget the capital gain tax rates. As far as buying now, well that would be bad timing, as we do appear headed into recession by next year. So, as you say shorting the indexes with inverse index funds would be a good bet IF you can time it right. This time you might.

    Market timing and trading is NOT a strategy that most individuals can be consistantly successful at. Buying low (-40%) after a major correction, be it gold or quality stocks, is the only other possibility for individuals to come out ahead in the long term (years).

  7. H. Craig Bradley | October 25, 2012

    CLINT EASTWOOD IS RIGHT AGAIN

    Sure looks by Shiller's Chart that a DOW 6,500 is a strong future possibility during a second Obama term. How many investors and pension funds are ready for that one?? ( Being cut in half once more). Add to that the report from Congressman Ron Paul that last week the FED bought $ 22 Billion worth of Treasuries and Foreign Investors purchased $20 Billion of Treasuries. Where did the money come from? This won't last and Clint Eastwood's latest ad is spot-on: " America is running out of time".

  8. William W. Andrews | October 25, 2012

    It's so rare to find good analysis. Excellent article!

  9. mcguireryan@gmail.com | October 25, 2012

    To some extent,, I disagree that buy-and-hold is not an investment strategy. I think it depends what you mean. I suspect that one of the reasons you speak out against buy-and-hold is that people have been conditioned to blindly buy (thus going all-in right off the bat) and blindly hold securities (thus ignoring fundamentals) without understanding the risks associated with a buy-and-hold strategy. For example, I researched a few companies that I think are good long-term opportunities, because they are 1) represent good value 2) have excellent management and 3) are posting strong balance sheets even though business is not booming. Strictly speaking, I'm not going all-in and holding. I am averaging in slowly. But this is all a part of a larger buy-and-hold strategy.

    Thanks

    • Keith Fitz-Gerald | November 5, 2012

      You are spot on Mcguireryan. I think we're in the same neighborhood only the language we use may have subtle differences. Thanks for your time and insight – Keith

  10. Robert w. | October 25, 2012

    I have just started investing on a small scale because money is tight. Alot of people said to buy silver,so i have but i do not see the prices going up as suggested.Should i sell or hang-on to my silver? Need advise and/or opinion.thank u robert w.

    • H. Craig Bradley | October 26, 2012

      SEC REGULATIONS PROHIBIT KEITH FITZGERALD FROM GIVING INDIVIDUAL INVESTMENT ADVICE HERE. ONLY YOUR STOCK BROKER CAN DO SO.

  11. T gibson | October 26, 2012

    GOLD……. V interesting…. So thats y it isnt breaking upwards!!!! Wat is ur call for the short term bottom…. 16.50 ? 1600 ? Or lower?…….. Do u think a jan 16 put option is ok or do we need to go further out in time??? And wat of SILVER? My charts seem to indicate a short term move down to 27!!! Is this feasible ….. Siver is piling up at comex and i cant see wat will push it up….. ( the timid trader)

  12. 000039897870 | October 26, 2012

    So, Keith, What ever did you do with that $1,000,000 bill I gave you in Seattle? You never asked me what I expected of you. You are supposed to make it real. Anyway, I just came home from Disney World where Dreams are supposed to come true. Wish, wish, wish.

    Just got my China visa-any good advice on how I can make good use of my time there? My company built 6 Habitat for Humanity houses there last year. They wanted me to pay $1000.00 just to go over and help the build. Maybe next time.

    You have the secret to making that $1,000,000 into $100,000,000, just use your magic wand. It should be FREE.

    Americans are the most generous people on the earth-we need to do what ever we have to to keep our system sound and successful.

    Carol Stenberg
    Seattle

    I'm trying to study Dr. Brown's Course on "How To Build A Million-Dollar Portfolio From Scratch" I really love Dr. Brown. He is very funny, but I'm affraid by the time

  13. Steve | October 29, 2012

    Hi, I do rely on the advice given to me by experts and I pay for it willingly. With reference to the advice to 'be ready to sell my gold and buy again at a lower price'. To be honest if I could time that then I would, but we all know that it is virtually impossible to time the market that well in gold, which I am sorry to say makes this advice extremely amateurish coming from an expert.

    Sorry to be so blunt Keith, if you could tell me when I should sell my gold exactly and then buy back I would gladly eat humble pie and bow to your superior expertise. Otherwise your article is extremely poor…..

    I await your guidance with anticipation.

    Kind regards
    Steve

    • Steve Christ | November 6, 2012

      Dear Steve,

      Thanks for taking the time to comment. In my capacity as Managing Editor, I find that people who take the time to post their own thoughts tend to be very well informed.

      But in this case, I am mystified. You take Chief Investment Strategist Keith Fitz-Gerald to task for failing to offer you specific buy and sell points; yet you do not offer your own.

      The truth is that Mr. Fitz-Gerald does offer extremely specific price points in his paid newsletter services. All our contributors do and if that’s what you’re after, I’d encourage you to subscribe rather than simply calling out his analysis as poor when countless investors have benefited from it over the years.

      That you may not agree with what he has to say is a different story. We respect that. He respects that. Discussion, is what makes Money Morning a fantastic resource for our experts and readers alike.

      In the meantime, please consider any of half a dozen techniques to manage your exits profitably. Mr. Fitz-Gerald, for example, is a keen proponent of trailing stops and “chandelier exits” as a means of letting the markets dictate your actions. Timing, as he has noted repeatedly in Money Morning, almost always ends badly no matter what asset class you are talking about.

      In closing, stay tuned. Mr. Fitz-Gerald is working on a follow-up article that does, in fact, talk about specific metals price points that you and other readers like you may find helpful.

      Sincerely,
      Steve Christ
      Managing Editor, Money Morning

  14. Steve Christ | November 5, 2012

    Dear Steve,

    Thanks for taking the time to comment. In my capacity as Managing Editor, I find that people who take the time to post their own thoughts tend to be very well informed.

    But in this case, I am mystified. You take Chief Investment Strategist Keith Fitz-Gerald to task for failing to offer you specific buy and sell points; yet you do not offer your own.

    The truth is that Mr.Fitz-Gerald does offer extremely specific price points in his paid newsletter services. All our contributors do and if that's what you're after, I'd encourage you to subscribe rather than simply calling his analysis poor when countless investors have benefited from it over the years.

    That you may not agree with what he has to say is a different story. We respect that. He respects that. Discussion, rather than personal attacks make Money Morning a fantastic resource for our experts and our readers alike.

    In the meantime, please consider any of half a dozen techniques to manage your exits profitably. Mr. Fitz-Gerald, for example, is a keen proponent of trailing stops and "chandelier exits" as a means of letting the markets dictate your actions.

    Timing, as he has noted repeatedly in Money Morning, almost always ends badly no matter what asset class you are talking about.

    In closing, stay tuned. Mr. Fitz-Gerald is working on a follow-up article that does, in fact, talk about specific metals price points that you and other readers like you may find helpful.

    Sincerely,

    Steve Christ

    Managing Editor, Money Morning

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