I think its time to flush out the conversation about whether we are going into a bear market, double dip recession, or whatever awful unknown awaits us. According to Investopedia, “A bear market is a general decline in the stock market over a period of time. It is a transition from high investor optimism to widespread investor fear and pessimism. According to The Vanguard Group, “While there’s no agreed-upon definition of a bear market, one generally accepted measure is a price decline of 20% or more over at least a two-month period.
On that measure the S&P 500 topped out at 1356 on July 7th. The recent intra day August 9th lows of 1089 represent a drop of 236 points or 19.69%. That’s close enough to 20% for me. Let’s call it a bear market that started in July. If you look at a whole host of stocks, though, they are down far more than 20%. Insider buying has picked up to levels not seen since the 2008 and 2009 lows. Even Warren Buffett said he had enough of the price decline and recently announced he was buying his own stock, Berkshire Hathaway, for the first time in 40 years.
So what do you do now? Pare back size. We hold a lot of cash. We may miss many opportunties but we sleep better with this gut wrenching volatility. That doesn’t mean we are all in cash, we’re not. We are about 20-30% invested with the balance in cash or short indices or stocks. Forget trying to hedge with options. Volatility has priced these so rich it’s akin to buying fire insurance while your house is burning down.
What you can do with options is sell credit put spreads on stocks you would be willing to own. For example MRK Merck is an attractive slow economy defensive stock with an attractive dividend yield around 4.9%. Let say you would like to pick it up at the Aug 9th low price $29.42. Try selling 10 of the 3o puts and buying 10 of the 28 puts. You have a maximum risk of 2 points if MRK goes below the 28 defensive put purchase. If Merck doesn’t go below 30 you kept the credit you earned from the put spread. If you get put the stock, well, you’ve bought Merck quite a bit cheaper than the $31.8o price the CFO and CEO spent over a $ million dollars accumulating during the August rout.
Now, I’m not advocating a full allocation to equities. Far from it. I rarely do that. But history has show that when you can buy decent companies at prices below what even insiders are willing to pay, you will with patience be rewarded. Could it be different this time? I guess it always could be different but if you asked me to bet on that, I’d give you odds six months to a year it won’t be different.