Even the Buy and Hold Bull Should Consider an Index Short Sometimes

Published on March 6, 2019 @ 8:11am

A modestly lower day yesterday across all of the major indices continues to suggest the possibility of an increase in volatility soon, but other than the Russell 2000 there are still no clear objective signals to suggest these markets are ready to back off just yet.

Although our newly added short trade on the Russell 2000 yesterday via TZA was up a few pennies by day's end, even that doesn't fully suggest the small cap sector is ready to rollover yet either. As a matter of fact, a number of our open small cap trades traded much better yesterday following Monday's market-wide weakness. However, we are starting to see our confirmed sell signal on the Russell 2000 Monday starting to play out - with TZA up almost 2% on the morning already.

Again, as long as the Russell 2000 doesn't make a new short-term high, we'll stick with TZA until further notice. The risk/reward is clearly there considering how fast and how long the recent market-wide rally has lasted without any sort of significant pullback along the way. Therefore, we're full willing to give up a few percentage point loss if we're wrong in exchange for some tremendous upside in TZA should our recent analysis end up being correct.

As for the broader markets, provided below are daily charts of both the NASDAQ Composite and the S&P 500 - the two most important indices for these markets anymore. As you can see, neither have really broken down yet, however, it is starting to look and feel like they may be on the verge of lower levels soon.

Basically, these markets are starting to look a little heavy again, but they've yet to clearly show they want to move dramatically lower yet. Therefore, we're not going to add any additional short trades until either the NASDAQ and/or the S&P 500 also confirm some sort of technical sell signal.

The bottom line is the bulls are still somewhat in control following the December 24th bottom, but that could very well change as soon as this week, or maybe even today. And, considering nothing affects the near-term price movement of an individual stock more than the broader markets' sentiment, even the long-term buy and hold investor should consider an index short at least a few times a year - in an effort to protect against developing weakness in even the most quality of names.

Further, although we still very much like all of our open ideas on a longer-term basis, it does not mean they're insulated from any potential market-wide weakness on a near-term basis. In other words, while even the most attractive small, mid and large caps can look very technically and fundamentally attractive on a longer-term basis, it doesn't mean they're not going to be subject to dramatic price swings once the broader markets finally decide to pull back for a while.

The bottom line is it's important to consider a hedge or an index short trade from time-to-time in an effort to make up for broader market weakness, while lowering one's cost basis in quality names over time.

As you can clearly tell, we're at another fairly critical pivot point for stocks on a near-term basis, and although we do strongly believe stocks will end up going much higher when it's all said and done, that's not likely to come without significant volatility along the way.

The takeaway today is if you're a long-term investor who's portfolio is well positioned to take advantage of the markets' next big bull run, you may want to consider buying TZA today, because should the Russell 2000 continue to move lower and lower in the days and/or weeks ahead, you will most certainly capture some nice gains in TZA along the way. Again, if the Russell 2000 goes down 1%, TZA will go up 3%, so you can see how big the gains can get if these markets do finally break down again on a near-term basis.

Conversely, we most definitely believe we've got some excellent exposure to some very quality names that should do well once these markets are ready to resume their bullish ways. However, we likely won't see any significant gains in any of those names until a point in time whereby the broader markets start moving higher again.

We're convinced they will. We're just not convinced they will without these markets pulling back first.