Image via Bloomberg Business Week.
Dow Hits 30000
In our post-election update last week, we offered our take on why the market had shrugged off the contested election:
In hindsight, the market reaction since the election is understandable. Of course, news of successful vaccines against COVID-19 by Pfizer (PFE) and BioNTech (BNTX) and Moderna (MRNA) buoyed stocks. But also, Biden and Trump are basically corporate-friendly. There are significant differences between Biden and Trump on other areas, such as immigration and foreign policy, but Corporate America would thrive under either. President Trump may be a populist, but the first major legislation he signed included a cut in the corporate income tax rate. Joe Biden may have been endorsed by the socialist Senator Bernie Sanders, but as Jacobin Magazine lamented this week, Biden has no plans of offering him a cabinet spot.
The market got more comforting news this week. Although President Trump continues to contest the election, he authorized the General Services Administration to cooperate with Biden‘s transition team.
…fight, and I believe we will prevail! Nevertheless, in the best interest of our Country, I am recommending that Emily and her team do what needs to be done with regard to initial protocols, and have told my team to do the same.
— Donald J. Trump (@realDonaldTrump) November 23, 2020
Also, as the New York Times reported (to the chagrin of progressive Matt Stoller) Joe Biden would appoint former Fed Chairwoman Janet Yellen as Treasury Secretary.
Janet Yellen is a deficit hawk who wants to cut Social Security, return to free trade, and strongly supports the World Trade Organization. Wheeee! https://t.co/dBmPLQeLcT
— Matt Stoller (@matthewstoller) November 25, 2020
Why Dow 30000 Now?
That’s a question Wayne Duggan at Benzinga raised on Tuesday. His answer, in part, was that “investors appear to be pricing in another aggressive round of government stimulus in the near term”. But according to the New York Times, Senate Majority Leader McConnell is offering a stimulus package about a quarter the size of the one the Trump administration offered before the election.
Master tactician Pelosi could have had a $1.8 trillion deal pre election and now will be lucky to get McConnell’s $500 billion deal. All while economists project double dip recession. https://t.co/fV8LaRRDLn pic.twitter.com/Tf5zvgEfmG
— Krystal Ball (@krystalball) November 22, 2020
Duggan also cited the development of the vaccines as a boost for the market. Despite the vaccines though, New York and California are implementing new lockdowns. So it’s possible investors have been overly enthusiastic about the near-term.
In Case The Next Stop Is Down
If you’re concerned about a near-term market pullback, here’s a simple way of protecting your portfolio. For the purposes of this example, we’ll start with these assumptions:
- Your portfolio is worth $500,000.
- It’s closely correlated with with the Dow.
- You have enough diversification within it to protect against stock-specific risk.
- You can tolerate a decline of up to 20%.
If you have a smaller risk tolerance, you can use the same approach entering a smaller decline threshold; similarly, if you have a larger or smaller portfolio, you can adjust Step 1 below accordingly.
Step 1
Divide $500,000 by the current price of the SPDR Dow Jones Industrial Average ETF (DIA), which was $340.43 as of Tuesday’s close, to get 1,664 (rounded).
Step 2
Scan for the optimal, or least expensive, puts to protect against a >20% decline in 1,664 shares of DIA over your desired time frame. Here, we’ve used the end of the year.
Screen capture via the Portfolio Armor iPhone app.
Note the cost here: $1,008, or 0.2% of portfolio value, which was calculated conservatively, using the ask price of the puts (in practice, you can often buy options at some price between the bid and ask prices). That worked out to an annualized cost as a percentage of portfolio value of 2.04%.
Step 3
Round up the number of DIA shares to the nearest 100 and repeat step 2.
Note that, in this case, it was cheaper to hedge rounding up to the nearest round lot. The cost was $816, calculated conservatively again, at the ask. That’s about 0.16% of a $500,000 portfolio, or 1.62% annualized. It’s something to consider if you’re risk averse now.
