Biden’s reversal on long-range missiles … Putin puts nukes into the spotlight … gold and oil stocks climb … should you be hedging your gains?
As I write Tuesday afternoon, the market is shaking off Russia-related geopolitical concerns that have been building over the last two days.
While that’s good for this bull market, let’s not overlook the risk of what’s happening.
To unpack this, let’s rewind to September. As the U.S. mulled authorizing Ukraine’s use of Western-made long-range missiles to strike deep inside Russia, Russian President Vladimir Putin said:
If this decision is made, then it will mean nothing less than the direct participation of NATO countries—the U.S., European states—in the war in Ukraine. And that will substantively change the very essence, the very nature, of the conflict. It will mean NATO countries are fighting against Russia.
Putin would go on to add:
Russia reserves the right to use nuclear weapons in case of aggression, including if the enemy using conventional weapons poses a critical threat.
With this as our context, here’s a Wall Street Journal headline from yesterday:
Biden Approves Ukraine’s Use of Long-Range Missiles Inside Russia
This is a reversal of Biden’s prior reluctance to authorize such weapons use. As to what might have changed, deputy national security adviser Jon Finer indicated that the introduction of thousands of North Korean troops onto the battlefield on behalf of Russia has influenced the Biden administration’s position.
This morning brought news that Ukraine has already launched these long-range missiles into Russia
The Russian Defense Ministry reports that its air defenses shot down most of the missiles. The fragments of one made it through Russia’s defenses, apparently hitting a military target but there weren’t any casualties.
In response, Russian Foreign Minister Sergei Lavrov said:
The fact that ATACMS were used repeatedly tonight in the Bryansk region is, of course, a signal that they [in the West] want escalation. And without the Americans, it is impossible to use these high-tech missiles.
In retaliation, Putin’s government just amended its nuclear doctrine, expanding the range of threats Russia can respond to using nuclear weapons. Now included are the same long-range missiles Ukraine just fired.
Is this just saber-rattling, or might Putin elevate the conflict using some sort of nuclear weapon?
On one hand, many analysts believe the nuclear threats are purely bluster. Here’s Newsweek:
Defense experts have previously cast doubt on whether Putin would act on his nuclear warnings.
“It’s a bluff,” Gustav Gressel, senior policy fellow at the European Council on Foreign Relations, told Newsweek in September. “If they’d mean it, we’d all have had a nuclear escalation already.” He described the change in nuclear doctrine as “nonsense.”
That sentiment was echoed this morning. Here’s CNBC:
“Putin is bluffing again,” Timothy Ash, emerging markets strategist at BlueBay Asset Management, said in emailed comments Tuesday.
“Putin’s bluff was and has been constantly been called — Putin is terrified of getting into a conventional war with NATO which he would likely lose in weeks,” he said.
These analysts are probably correct (we hope). Putin is unlikely to use a full payload nuclear weapon, knowing it would usher in Armageddon. However, this is still quite the game of chicken.
But Bloomberg writes that this nuclear “will they/won’t they” is missing the point:
But is Putin merely bluffing? Is Kim? And what about Xi? It’s hard to say.
As it happens, though, Russia, North Korea and to a lesser extent China have something in common beyond a shared hatred for the US: the knowledge that, in a full-blown conventional (meaning non-nuclear) war against America, they’d lose. So, they’re forming strategies to compensate for that weakness with nukes.
The idea is not to attack the US with intercontinental “strategic” weapons, because that would invite retaliation and total destruction. It’s instead to ward off the superpower, or to end an ongoing war against it on their own terms, with the credible threat to drop “tactical” nukes — typically with smaller payloads and shorter ranges — in the theater of war.
Those blasts would be intended to shock Washington into backing off rather than risking escalation into a full-blown nuclear exchange, and mutual annihilation.
Bluff or not, tying back to the stock market, what we can say is that this entire situation is not good for a “peace dividend” that would be a tailwind for stocks.
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While we hope this situation doesn’t escalate, it’s a good reminder of why gold and oil play an important role in a well-balanced portfolio
As I write Tuesday, gold is up roughly 2% since yesterday, and oil has added more than 3%.
It’s easy to get caught up in day-to-day market movements of these two assets and second guess yourself…
Are things looking overextended? … will dollar strength kneecap gains over the next few months? … how might government policy be a fierce headwind looking forward?
While those are fair questions for shorter-term traders, if you’re a longer-term investor who owns high-quality oil stocks and gold, these questions are distractions. To illustrate, below are two charts to keep in mind.
The first compares the SPDR Energy Select Sector ETF (XLE) (in black) with the S&P 500 (in red) over the past 25 years.
When reinvesting dividends, XLE has destroyed the S&P by nearly 2-to-1.
Now, the naysayer might respond, “Jeff, that’s the power of reinvesting and compounding your dividends. In the real world, people don’t do that. They take their dividends and use them to pay bills or go on vacations.”
First, this assumes dividends were reinvested in the S&P as well. But let’s ignore that and use the pushback as a springboard for our second chart.
As you’ll see below, gold – which pays no dividends – has more than 2.5x’d the S&P 500 over this same period.
Most investors have no idea that gold has crushed the average S&P stock over the last 25 years.
But beyond owning gold and oil, should you be hedging your portfolio with put options today?
That might be an odd question as you watch your portfolio roar higher as this bull continues. But it’s those gains that you’re enjoying that we want to protect.
Now, I just used the term “options.” If your immediate reaction is negative, I get it. In many investment circles, they’ve developed a reputation for being a fantastic way to lose huge amounts of money fast.
But that’s an unfair characterization. It’s a bit like concluding that all vehicles are terrible and should be avoided because some people are bad drivers and cause wrecks.
Like a vehicle, an option is just a tool. Whether its impact is good or bad depends on the user.
Sure, there are some gunslingers out there who use options recklessly, but many of the world’s most successful investors use them to hedge their portfolios. This includes Bill Ackman, Michael Burry, Ray Dalio, Stanley Druckenmiller, and George Soros.
If you’re less familiar with options, a “put option” is an investment engineered to increase in value as its underlying asset’s price falls.
For example, say you own loads of Nvidia. You’ve been thrilled, watching it soar thousands of percent in recent years. But with Nvidia’s earnings report coming out tomorrow, you’re concerned that the chip giant might finally disappoint Wall Street and implode. If that were to happen, the huge gain you’re sitting on would suffer a major haircut.
At the same time, you don’t want to sell your Nvidia. Doing so would mean you’d have to deal with huge capital gains taxes. Plus, what if earnings are good and the stock continues climbing?
To help navigate this situation, you could buy put options
Simplistically, if Nvidia were to report underwhelming earnings tomorrow causing its stock to tank, your put options would roar higher, helping offset Nvidia’s losses.
On the other hand, if Nvidia delivers another blowout report and its stock races higher, then the money you spent on your options would go to zero, like an insurance premium.
Many investors love the idea of put options until this little detail. Somehow, the idea of put options that don’t pay off feels like wasted money.
But does that make sense?
Many investors protest the idea of buying puts to hedge their portfolios, but don’t think twice about buying home, car, or life insurance.
By this logic, we should be angry when a tree doesn’t fall on our roofs after we’ve made our home insurance payments.
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But with stocks at nosebleed valuations, and investor portfolios swollen with gains, now has never better a better time to understand options
To truly understand how powerful these options plays are, I’ve put together a special presentation that will help you identify the best opportunities for quick options plays on the market.
You’ll also understand how trading pros protect their portfolios from market uncertainty by adding upside and downside coverage that allows them to stay nimble whatever the markets throw at them.
With this presentation, you’ll get a clearer picture of how volatility shapes the options market, and you’ll gain the depth of understanding necessary to execute creative trades based on all the market criteria I’ve outlined above.
Though we’ve highlighted using options for defensive purposes in today’s Digest, they can also be a fantastic way to play “offense,” resulting in huge gains – sometimes in as little as hours.
Back to Jonathan:
By hedging your short-term risk and piling into trades at the right time, you can find some of the most powerful opportunities for gains in the stock market.
Consider this…
When the Nasdaq popped 2% back on Sept. 19, you could have made 344%, 1,402%, or even 1,788% and more with this kind of trade. With those kinds of gains, you could have turned a $500 stake into $2,220, $7,510 or $9,440 – all in just a few hours.
Stepping back, there’s a good case to be made that this bull market will extend into 2025, possibly beyond
But no one knows. And the news out of Ukraine/Russia is a reminder that Black Swan events can and do rattle the markets.
If your specific financial situation can’t afford a steep decline in your portfolio… if you have a handful of stocks that are now sitting on enormous gains that you need to protect… or, if you just want to learn how pros use options to stay in the market while limiting their downside… I hope you’ll join Jonathan next week.
Even if you don’t use them, you’ll be a better investor for simply understanding why guys like Ackman, Dalio, and Druckenmiller do.
