How to protect your portfolio when the sharemarket gets jumpy

Sharemarket analysts are nervous, so finding a way to protect your portfolio should be a matter of priority.

I have to say there is a real sense of nervousness about the performance of sharemarkets over the next couple of months.

A couple of factors are playing on the minds of the share gurus:

The fear of last year’s June share rout playing out again with tax loss selling.
The debt ceiling and regional banking crisis in the US crunching markets.
The uncertain future of interest rates – have they peaked, is there further to go, when will rate cuts begin?

And when there is uncertainty, markets start to focus on warning signs, both in terms of news and on the charts.

Mathan Somasundaram from Deep Data Analytics posted this chart of the ASX 200 showing a “head and shoulders” pattern, which is a precursor to a significant drop in sharemarkets.

Source: Deep Data Analytics

And then the charting website, Game of Trades, showed this chart of the US S&P500 index with a pattern mirroring the 2008 market crash.

Source: Game of Trades

The S&P 500 is up nearly 7.5 per cent this year, but roughly 70 per cent of that gain has been driven by the 10 largest stocks in the index. And that top 10 is dominated by tech companies.

In fact, the five largest are Apple, Microsoft, Alphabet, Amazon and Nvidia. Apple and Microsoft alone make up 14 per cent of the index.

Societe Générale said in a note this week that without the big gains for AI-related stocks Nvidia, Alphabet and Microsoft, the S&P 500 would actually be negative this year.

Options to protect your portfolio

If you’re nervous about the sharemarket crashing over the next few months you can do a number of things to protect your portfolio.

1. Diversify

Diversification is a mantra in financial circles. The logic is simple: if you put all your money in only one investment, it’s clear your fortunes will live and die by its success.

But splitting that money into a range of investments with a low correlation (say businesses in different industries) will protect you if one of them falls over.

It’s important to take a holistic view of your investments when thinking about diversification and not just focus on the share portfolio. Don’t forget about your superannuation, property and any fixed income or business investments too.

2. Invest in great businesses

Great businesses don’t fall over in a light breeze. Even with a perfect storm on the horizon, a great business will batten down the hatches and emerge stronger than before.

The market knows this and will often support the share price of a solid company when times get tough and put a rocket up the future recovery.

3. Take out insurance

Many brokers will allow you to set a stop loss order on your share positions.

A stop loss will automatically process a sell order if the price of the share falls below the level you set, and therefore limit potential losses.

While they can be a great way to protect your portfolio, be careful with how you use them.

If you set them too high, it’s possible to trigger sell orders during even minor market corrections.

A lot of professional investors also use strategies to “short” the market using things like options and Exchange Traded Funds. Shorting a stock, or market, is where an investor “sells” first hoping to “buy” later to complete the transaction at a lower value and make a profit. It’s complicated, but effective, and you should only do it in conjunction with a good broker or adviser.

4. Get good advice

Not sure if you’re sufficiently diversified? Stop loss orders over your head? A financial adviser or broker can help.

An adviser will assess your risk profile and help adjust investments accordingly.

For investors with a low tolerance for risk, an adviser will be able to put a strategy in place to protect you as much as possible in the event of a major downturn, while keeping things on track to achieve your financial goals.

Sharemarket 101: How to find a good broker and why you need one

5. Invest in an ETF designed to profit from a falling market

One of the less complicated options, and often less expensive, is to invest in an ETF designed to profit from a falling market. They do this through a range of options and financial engineering strategies.

One of the biggest in this area is the BetaShares Australian Equities Strong Bear Hedge Fund, which has a portfolio where for every $1 the sharemarket falls, it goes up by $2.50.

This ETF came up on my sharemarket show The Call (www.ausbiz.com.au midday-1pm) this week with Henry Jennings from Marcus Today and Andrew Wielandt from DP Wealth Advisory.

Both agreed this ETF provided good protection against a falling market for those who wanted some “insurance” for their portfolio.

But they warned this is not a “set and forget” investment. You put this ETF in place when markets have started to fall and investors are gloomy. But it should be closed quickly when markets turn.

6. Other options

Sell stocks and increase cash levels – this has be assessed by taking into account the tax consequences.
Organise an options strategy which takes advantage of a falling market.
Likewise, use a futures market strategy which shorts the market.

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