They say that “The trend is your friend”, right? Well, nobody talks about what happens when the trend isn’t your friend, and that’s something to be concerned about.
Last week, the Nasdaq 100 broke below its 50-day moving average. Just days before that, S&P 500 and the Dow Jones Industrial Average did the same.
This means that all three of the major indices are breaking critical trendline support. That in and of itself has negative consequences.
Focusing on one of the three, the Nasdaq 100 is the trendline to watch.
The index houses the large cap technology companies like NVIDIA (NVDA), Microsoft (MSFT), Amazon (AMZN) and Google (GOOG).
One of my “Ten Commandments of Trading or Investing” is that the market’s are driven higher by speculation, not necessarily fundamentals. The last two weeks have taken investors’ reason to speculate on higher prices away as technology companies at the heart of the market’s strength haven’t raised the market’s expectations for their forward-looking growth.
This clashes with the overly optimistic sentiment that has driven these stocks well above their valuation to create a “sell the news” market, breaking the market’s bullish trends.
This week, we’ll start to see earnings reports come in from the big banks.
Names like Goldman Sachs, Morgan Stanley and JP Morgan Chase will provide their quarterly results. More importantly, those companies are going to give us a look into their expectations for the next three to six months.
Don’t count on a rosy picture….
Economists and bankers are both worried about two things.
First, the risk of returning inflation.
The Fed’s fight against inflation has been effective. Both the Consumer Price Index and Producer Price Index have dropped considerably, but the drop has slowed.
Jerome Powell and the Fed warned us that there was a possibility that inflation could be more persistent as it neared the Fed’s target. That’s exactly what has happened.
In addition, the uncertainty that is growing around President-elect Trump’s tariff policies raises the potential for another fight with inflation in 2025.
Which brings us to the second concern, Interest rates.
Just a month ago investors were under the assumption that interest rates would move another 1% lower in 2025. That’s changed.
As of today, expectations are that interest rates will only see a cut of 0.5% in 2025, halving the market’s expectations.
It doesn’t seem like that’s a lot to worry about, but the effect on consumer spending, the housing market and other economic activity that are driven by lower rates will be negative.
The Fed’s possible hold on interest rates, earnings season and the market’s technical breakdowns are all happening at the worst time.
January and February are two of the weaker months of the year for stocks.
For now, you should expect to see selling pressure remain constant through the next two months, driving prices another 5-10 percent lower, and that’s the optimistic outlook.
With that in mind, the way to position for a rough two months is to consider two defensive moves.
Every investor out there is well-served to review their portfolio holdings on a regular basis. Now is the time!
You’ll find that the nimble traders are setting stop-limit sell orders to ensure that losses don’t get out of control. This is an easy way to take the emotions out of investing that pays off over the long run.
Here's a quick look at how to use stop-limit orders.
One suggestion, if you sell a stock that you want in your portfolio for the long run consider setting a target price at which you’ll buy it back. This will help to make sure that your defensive move to avoid losses pays off by buying the stock back at a lower price.
Consider adding an inverse Exchange Traded Fund (ETF) or a defensive put to your portfolio.
Inverse ETFs are an investment that increase in value as the market goes down.
Click here for a brief education on inverse ETFs.
For example, the Ultrashort QQQ ETF (QID) goes up roughly 2% for every 1% decline in the Nasdaq 100.
Adding the QID to a portfolio will help to offset losses that you would see from holding large cap technology stocks in your portfolio.
As it stands right now, the QID shares are trading 14% over the last three weeks as the Nasdaq 100 has fallen about 7% over the same time period.
The ETF is an easy addition to a portfolio since you buy it just as you would any stock.
Pro tip: Don’t get too greedy with a hedge like the QID. Set a target price for closing the positions. There’s nothing worse than holding a portfolio hedge too long to have it start losing money.
As of now, my charts suggest that a potential closeout for a QID position would be between $37.50. That’s 10-12 percent higher than where it sits as of this writing.
Put options are a great way to protect a portfolio in these conditions, this is how the pros do it.
Put option values increase as the underlying stock or index goes down.
This is a more advanced approach to hedging your portfolio, but its also the most efficient. Think of this approach like you would a term insurance policy. You pay a premium for a put option for a certain time period’s worth of protection. At the end of that time, the protection expires.
Read more about this approach here.
I’ll cover the use of all three of these hedging approaches next week with a little more detail and examples of each.
Until then, stay safe in the markets.