How to hedge your portfolio during market volatility

If you're going to spend a lot of money on something, investors are going to want to eventually see returns. That's the case in Big Tech, where tech giants are spending billions of dollars on building AI products, but have yet to show the sort of result investors have been hoping for.

In this episode of Stocks In Translation, Yahoo Finance's markets and data editor Jared Blikre, along with Yahoo Finance producer Sydnee Fried, are joined by Trent Smalley, investment adviser and portfolio manager at JSPM LLC. They discuss Big Tech's big capital expenditures and growing investor frustration with it. They also explore the concept of hedging, an investment strategy designed to minimize the risk of adverse price movements in an asset.

The conversation also delves into the summer fluctuations in the stock markets, highlighting the unwinding of the yen carry trade that led to a huge market sell-off earlier in the month.

Blikre and the team also offer investment strategies tailored for younger investors and discuss the suitability of the 60-40 strategy. “I would… think of themes that will be present throughout somebody’s lifetime,” says Smalley. “Technology will be there. Healthcare and the aging population will be there… Staples will be there."

For more expert insight and the latest market action, click here.

Find more episodes of Stocks in Translation here.

This post was written by John Tejada.

Video Transcript

Welcome to Stocks in translation.

I'm Yahoo Finance's Market and data editor, Jared Blick and I am joined by the People's Voice that would be Sydney Fried.

And uh before we jump into the conversation, be sure to like, subscribe and comment on stocks and translation on Spotify, Apple Music, youtube or wherever you get the podcast.

Today, we are joined by Trent Smally.

He has a charter market technician, a UFO enthusiast and portfolio manager at Js PM LLC.

Welcome guys.

Now on the docket today we are going to be talking about normalization.

That's in terms of policy, interest rate, even inflation.

Our phrase of the day is hedge.

You can hedge your bets, you can hedge a fund.

Many have tried some have succeeded.

And this episode brought to you by the number 199 that eye watering sum is what Wall Street expects.

Five of the world's largest tech spenders to shell out on A I this year alone.

So S Trent uh markets are settling down from their close encounter uh of the Vix kind.

Last week we had the Vix trading in the mid sixties.

It's now down to the 17 level is just crash back to earth.

What do you make of all this?

I was thinking actually just this morning, I was like, there has to be some record of this might be the record.

Actually in one week or five or six training sessions, the vics going from the 60 to 65 to 17 or 18 where one day, that one day record was just, I thought it had to be close.

I thought it had to be close.

Well, I think with the whole Japanese Yen carry trade last week, the market obviously had a bit case of the summer Ys and it didn't help that, you know, over the weekend, the news hit that Warren Buffett had sold a significant stake in a very large position in apple.

He still owns a ton of apple.

Uh But I think that and you know, the whole Japanese Yen carry trade situation was kind of a perfect storm that in a super low volatility environment, it just kind of lit a match.

We tend to get those perfect storms like once every few years like clockwork.

Uh I wanna get to our word of the day because this kind of encompasses what we're talking about here today.

It is hedge a word that I know is near and dear to your business here.

Trent A hedge is an investment strategy used to reduce the risk or at the risk of adverse price movements in an asset.

It typically involves taking an offsetting position in a related security using derivatives such as options or futures to protect against potential losses in an investment portfolio.

So you want to protect against losses.

What does hedge mean to you?

Just that, I mean it, you, you can, you can hedge by raising cash.

So if you have uh you know, 90% of the portfolio invested, you can, you know, trim some positions going into volatile periods or like you said, you can use derivatives such as futures or, or put options uh for to hedge the downside risk.

Let me ask you, uh the term hedge fund do hedge funds, hedge, what, what is the deal with what they're called?

It's a bit of a well bit of a misnomer there.

Some of them do.

Some of them are, you know, there's umpteen hedge fund strategies out there, but a lot of them will take both long and short positions um either through shorting stocks outright or uh using derivatives or finding assets that are either not correlated at all or inversely correlated with the majority of their long holdings.

But the term hedge fund, it's, it's just kind of a strange, strange use of the word.

Yeah, because some of them don't hedge, some of them are long only.

So it just basically means they can charge two and 20.

I want to ask you about some of the hedging that you do on behalf of some of your clients.

Uh you and I met at a CMT event that's a chartered market technicians and uh you know, way back in the day when the futures market were invented, ostensibly it was for this purpose to hedge physical crops or maybe oil production or something.

Tell me the services you provide to the small, small uh the small farmers who are pretty much disappearing.

Sure.

So if, if you're a farmer and you are going to be harvesting and then selling your crops later in the year and then let's say it's March uh to lock in that price.

You can basically go into, we'll just use corn as an example.

You can go into the futures market, sell future short in a uh basically in a balance that would offset.

So if you have 100,000 bushels or 200,000 bushels or whatever it is, you go in short, the number of futures contracts, you would need to cover that position, thereby basically locking in your uh gains that you will look to sell the physical commodity uh in the fall.

And you can actually do that on the opposite side, you don't necessarily do this.

But if you're buying the grains or you want to buy the oil, you can lock in a future price as well.

Um Tell us uh lots of strange things going on in the market now, but just tell us on a day to day basis.

What are some of the concerns that you see and some of the surprising things you see in the market right now.

Yeah.

So I think we've come to the point now where uh the Federal Reserve who has a dual mandate of both price stability and full employment, uh the focus for the last two years and for good reason, has been on the infl inflation part of that.

I think the scales have tipped now that they need to be much more focused on the employment piece of that.

Now we're watching those jobless claims this week and seeing if they spike higher and knowing full well that not maybe in every circumstance, not right away but A I is going to change the jobs picture as we know it.

And when you see these jobs start piling up, the job loss is piling up, you start to get a little bit concerned that you can't just turn the ship around right away just like when you raise interest rates, it takes time for that to flow through the system long and variable legs.

Exactly.

There's long invariable lags on the opposite side too.

So with some of this changing picture that we're seeing with the, you know, surge of A I potential rate cuts in our future, kind of something with some job losses that we're seeing.

How should investors think about hedging their portfolio, especially maybe um early investors, people who are kind of just starting out and don't know much about how to handle some of this volatility and changing landscapes.

Yeah.

Um, for a younger investor, I think the best thing that you can do if we're, if we're talking somebody that maybe just got their first job, you really don't have a lot to worry about.

You've got 20 to 3040 fif, I mean, if we keep going the way we're going, you know, the average life expectancy will be 90 or 100 years old.

They've got 70 years to invest.

If you could go back 70 years and invest in the S and P index, I don't think there's going, there's always gonna be tumultuous times in markets.

But if you look at long term returns on average, just using the S and P 500 you can bet somewhere between 8 to 10% annualized per year.

Sometimes it's lumpy, sometimes you get 30% a year.

Sometimes you're like 2, 2000, 22 you're down 20%.

But if you're using a dollar cost averaging strategy over time, young people don't have anything to worry about.

It's the people that are nearing retirement and those that are in retirement that they want to take a little bit more caution.

Maybe invest in bonds, maybe if they've got a 6040 allocation, maybe they do 5050 well, some uncomfortable.

So who is 60?

40?

Really?

For?

So you is young people don't need bonds or just later in life.

How does that work.

Yeah.

I mean, I would personally say young people don't, uh, need bonds unless they get extremely uncomfortable.

But I, if you're a young person and every two weeks you get paid by your company.

If you're lucky enough, you've got a 401k and you've got a company that will match a certain percent of that.

You want the market to go down.

Uh, and bonds are there to reduce the volatility of a portfolio.

But if you're young enough, really none of that matters, you should want the market to go down because every day that you get paid every two weeks, you get to buy more and just keep buying well.

So sticking with this younger investor, then what are, do you just pour your money into something like tech at that point and hope for a lot of growth because obviously you have a long runway until you need that you're shunning bonds.

Do you do the opposite?

You just go all in on high beta.

It's a good question.

I think it kind of comes down to the individual's personal, maybe risk tolerance.

If you're somebody that finds yourself watching stocks move day to day, week to week, month to month and that makes you uncomfortable.

You can do things like invest in maybe large cap only or invest in individual sectors like maybe maybe in the X LP like the, the staples or health care.

Generally, those are industry sectors that exhibit a bit less volatility than your high tech sectors.

XL K, I have an odd follow.

If you're someone that's only in invest, you're, let's say you're a young investor, you don't know that much, you're investing in ETF S, it's kind of, you're just tracking the major indices for the most part.

Like, do you just keep piling into those same ETF S?

Like I understand.

OK.

Diversify.

But if you're, if you're kind of going into OK, this large cap ETF, this other large cap ETF should you pile into one?

Do you diversify?

And within that?

How does, how does that work?

Yeah.

So if you buy a general ETF like the spy, basically, you're getting the 500 largest in terms of market cap companies in the S and P as time has gone on.

Uh I can't remember before.

It was everything is getting more and more heavily tech technology weighted and for, for good reason, but years ago it was energy was a much bigger portion of that.

So if I don't think you want to have all of your eggs in one particular sector, now, if you're super young, I would probably steer clear things like the utilities.

I don't think you really need too much exposure there.

Um But I would just, just think of themes that will be present throughout somebody's lifetime.

Technology will be there, health care and the aging population will be there.

XL V. Um Staples will be there it doesn't matter what the world does, we're all gonna buy toothpaste and soap and all that boring stuff, except if it's the apocalypse, then your money is not gonna be, market is not an issue.

You will have bigger problems.

All right, we got to take a short break here coming up.

We are going to be talking A I Capex, what the largest tech companies are spending on A I this year and in out of this world who wore it better searching for unidentified financial opportunities.

All right, this episode is brought to you by the number 199 as in billions of dollars.

That is the total estimated 2024 capital expenditures or Capex by Amazon meta Microsoft alphabet and oracle.

And that's what the street thinks they will spend on artificial intelligence research this year.

Up 28% from the prior Trent.

The money is starting to get real here, $200 billion.

And that's just what they're spending on research basically, right.

And we saw it first and foremost um in the believe it was the first quarter of 2023 last year with the huge boom in new sales at NVIDIA.

And um that is going to continue, I kind of picture this huge, it's an infrastructure build out for the next wave of technology and artificial intelligence that doesn't take place over one quarter or two quarters or even one or two years.

This is a massive build out that's gonna take more and more time and you just have to kind of listen to if, if, if you're super interested in this stuff, like, obviously, we are uh listen to a lot of conference calls because there is no better way to get information and listening to the management teams because they listen to Microsoft, listen to Andy Jasse at, at Amazon and, and Jensen Wonga nvidia.

They tell you where this is all going and to the extent that you can forecast the stuff.

I don't see it slowing down anytime soon.

By the way, you mentioned, uh earnings calls, if you want to find an earnings call, you just type in the company name like Microsoft Investor Relations, take you to that section of their website and you can see the schedule there.

Uh sometimes they have a password, sometimes it's hard to get on, but for the most part, that's how it's done.

Yeah, I recently read that Capex is kind of like a way to return capital to shareholders.

But how does that work?

How does spending money return value to share?

Sure.

So if you looked, if you look at an individual company, Capex, generally, what they're referring to is to just the capital expenditure.

So they're taking the top line revenue growth.

So say they grew at 10 or 15% year over year.

They're taking that and they're investing that into expanding their business.

It's a build out phase and we're just starting to see in a couple of companies, some of the benefits that are just beginning to pay off in this investment.

But assuming that you can take that revenue growth and invest it back into your business and the management team, I is very competent in terms of capital allocation.

If they can invest that in, back into their business at a high rate of return, that's where compounding comes from.

So if anybody who's taking an intro to finance class, they need to talk about, I'm taking it right now.

Oh, good for you.

Good for you.

Well, you're gonna learn to compound right now in this very podcast.

So one of the most important things and this, I don't know why, maybe because it just gets kind of into the weeds and it doesn't make for good TV.

But if you find a company, the first thing I look for is return on capital, there's several metrics with this, there's return on equity, there's return on invested capital or RO IC, there's return on capital employed, which is ro ce look at those things first and the percentage that you get kind of on a normalized, just take maybe a 3 to 5 year uh scale.

If that's above their cost of capital, they are going, it's a mathematical certainty that this company is going to generate value in the stock price will follow in time.

I find, I find that interesting if you're, so if you're trying to invest in a single stock, is that your advice to look at, like, kind of look at these numbers before, which are available on Yahoo finance website, by the way, they are all of them.

But what if you're not?

What if that doesn't come easy to you?

Sure.

So if that stuff doesn't come easy, invest in an index, that is, I mean, don't do it if you go and pass it.

No, I mean, I'm from Omaha.

So even the probably the greatest investor of all time said the vast majority of people uh should index and Charlie most part, I agree with them, the vast majority of people unless you have a real interest in this stuff and you want to get into the counting weeds and capital allocation, weeds and so forth most people and you'll do just fine if, if you save more than you spend and you invest over a long period of time, it, it will work going back to Capex.

Wasn't there kind of like a recent scare from Wall Street where people were worried that A I wasn't returning revenue kind of fast enough to these companies asked Microsoft about that one little copilot.

Yeah.

Um We are really, really impatient people in as in everything.

If, if you want to build muscle at the gym, you want it to be in a week.

If you want to lose weight, you want it to be in two days.

If you want to study finance, you wanna read one book and then, you know, everything and life doesn't work like that.

And although I think this is going to start playing out maybe sooner than people expect.

It's like we started to see the investment last year and boy, we better see some return on that investment right away.

Like guys, this is if you're building infrastructure, roads for a new city, they're not gonna be flooded with cars immediately.

It's gonna take people some time to find their way around.

And so it's coming, it's coming.

All right.

Hold that thought.

We want to keep it on that track on this episode of who wore it better.

We are blasting off into new frontiers with out of this world investments.

We've got space tourism, space exploration, quantum computing, clean energy, 3D, printing artificial intelligence, not just fodder anymore.

No, these are cutting edge sectors where real money can be made.

But who is leading the charge here are space stocks shooting for the stars or does the future belong to A I?

What if, what is the next big unidentified financial opportunity or UFO as we are calling them Trent.

I love UFO S. There's a company out there.

It's, we don't own this.

Uh and it's not gonna fit the mold of our fundamental criteria, but one that, that it's, it's called Rocket Lab.

It's gonna be fun to keep keep an eye on it just to see what they can do.

The problem with this higher interest rate environment that we found ourselves in.

And the, the lesson a lot of us got taught in 2020 when I started in the business, it was 2006.

And by and large that entire time, uh rates had been fairly low, abnormally low for a very long period of time.

So you had to pay almost no attention to valuation and you didn't have to worry about the kind of the debt to equity ratios in these companies balance sheets.

But as rates start to come down and the cost of capital goes lower, there's going to be some really incredible things like like space exploration, like the solar industry hope would be able to get back on some solid footing because there's a real need for energy, energy infrastructure, electricity and power generation.

Uh So those are the places I would kind of focus on to keep your eye out for as rates rates come lower.

How do you go about picking like to me space tourism, that's like a unique sector if we want to call it that like sure we have consumer discretionary, we have materials, those are like set S and P sectors.

How do you kind of decide to wade into investing in something like space tourism?

Probably the same way that you would decide whether or not to take a space to her?

I mean, pay a lot of money.

I mean, right now it's very risky.

Uh, over time, we may, with the benefit of hindsight in 10 years, we, we may look back at this show and be like, boy, what did the opportunity of a lifetime at the time seems super risky.

We're in a high interest rate environment.

These companies, we're just getting started in a very difficult place for a brand new start up to get going.

But who knows?

I mean, it's, I would try to find an e I'm not aware of one but I'm sure there's already an ETF for this and just keep an eye on the, the, the companies, the holdings within there and just kind of see who becomes the forerunner.

Would you travel to space?

I think so.

No, no, no, I get homesick.

Yeah, it's scary.

I have, I have another question.

So you look at both technicals and fundamentals.

Most of our guests tend to focus on one or the other.

How do you use them together?

So the fundamentals lead me to the what?

In other words, if you're going to invest in individual businesses and I say invest different than trade very, very different.

I've done both.

I do some of both.

I do.

The older I get, the less I trade, the more I focus on the investment.

Is it attention?

Like how do you differentiate those two words?

Because I think that's kind of important.

Yeah.

Yeah.

So I think it was in Seth Klarman.

So Seth Klarman, Ceo of Bal Post Group, uh brilliant kind of from the School of Buffett.

Um, he had a book called Margin of Safety that is out of print.

If you can find it on Amazon or ebay, it's like 10 or $15,000.

I was lucky enough to get my hand on a copy last year because the Columbia Business School Library had it and how he, I kind of identified trading was guessing what the next guesser is gonna guess just if you can guess better.

And so as a trader, I just tell people if you're a short term trader, don't bother with fundamentals because you're kidding yourself.

If you think the fundamentals of these businesses are changing tick by tick or you might get some volatility off an announcement, but that's, that would be the limit.

Trading for income and investing are while you might be using the same vehicles.

They're two totally different things.

Is it smart to trade if you're a young investor?

I mean, sure, I get that you have to kind of measure your own risk tolerance.

But do you think it's a good move for people who have time to try it out?

Yeah, I mean, I certainly did and, and, um, I would say that if you are interested in trading, do it with a sum of money that you're ok losing and don't commingle the two things if you're an investor and you're just starting out the foolproof way to get where you need to be is to dollar cost average index funds.

It will not fail you over a long period of time trading will fail you.

It fails almost everyone.

There are, the day trading statistics are horrible.

Something like 95.

It's, it's more than 95% failure rate within one year, uh, accounts getting wiped out.

I want to ask you, we got about another minute here.

You studied mixed martial arts in college with some people who would go on to be in the UFC.

How is that?

Not one of my better judgments at the time.

But I worked out at a gym in, in Omaha, Nebraska and a good friend of mine taught a, uh mixed martial arts class at that gym and I was working out one day.

He's like, why don't you come join us?

And I was like, that seems like a good workout, good cardio, you know, good strength training.

And I come to find out somebody walks in and they're like, you know who that is?

And I was like, no, they're like, oh, he just had a UFC fight a month ago.

And I was like, he's like, he's your partner today and I was like, excuse me?

No.

Yeah.

And so I got roughed up pretty quick by real fighters and found out pretty fast that it wasn't something that I would be pursuing, that's not a, that's not a long term uh viable strategy.

I don't think so, but investing is correct.

We got to leave it there.

We have wound things down here at stocks in translation.

Make sure to check out other episodes of our program on the Yahoo finance site and mobile app.

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Signing off.