The S&P 500 Probably Won't Crash By 50%, But If It Does, Gold Won't Protect You--Here's What Will.

The S&P 500 Probably Isn't Going To Crash 50% Anytime Soon

Raising the possibility of a 50% market crash always grabs attention, as does promoting the benefit of holding gold in a portfolio, as the title of Wealthion's recent Zero Hedge post does ("Will the S&P 500 Crash By 50%? How Gold Could Protect Your Portfolio"). I was all set to argue against the idea of a 50% market crash this year, but then I watched Wealthion's interview with market technician Chris Vermeulen, and it turns out he's not calling for that. I've set the video below to start at Vermeulen's global market prediction toward the end of the interview. 

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It turns out Vermeulen isn't calling for a 50% drop in the market this year, which makes sense. The Fed not raising rates in spite of embedded inflation and the federal government running unprecedentedly large fiscal deficits are both inflationary, and stocks are inflating along with fast food worker salaries, Big Mac meals, and much else in our economy. Vermeulen sees the possibility of a 10% to 20% correction by the end of this year. 

That seems possible in the following scenario. Let's say Trump wins the election in November, and then calls for major deficit reduction to rein in the inflation that got out of hand during Biden's tenure. That could send stocks down (and as far as Trump would be concerned, better to have stocks crash while he's still President-Elect than President). 

Where Vermeulen sees the possibility of a stock market correction extending down to a 50% drop is in 2025. I guess it's possible, but I don't claim to have any visibility into that. 

And Gold Isn't Going To Protect You Against A Market Crash

That's the second thing I was going to argue against here. I have nothing against gold--I currently hold shares in a gold miner I've written about on The Portfolio Armor Substack, Orla Mining Ltd. (NYSE:ORLA), at an average cost of about $2.90. ORLA was up 25.23% YTD, as of Wednesday's close, while the leading gold ETF, SPDR Gold Shares (NYSE:GLD) was up 12.78%--they are both up this year because gold rises in an inflationary environment, but a market crash would be deflationary. In fact, the former Credit Suisse strategist Zoltan Pozsar argued a couple of years ago that the Fed would deliberately try to sink stocks to cool inflation. 

The NY Fed wunderkind-turned-Credit Suisse strategist on why the Fed's helicopters are dropping "financial napalm" this time. $SH $WEAT $TECS $BOIL https://t.co/hKLjrgLKse

— Portfolio Armor (@PortfolioArmor) May 17, 2022

Little did Pozsar know that the Fed would decide to let inflation and the markets rip instead of sabotaging Biden's reelection prospects, but here we are. In any case, as it turns out, Chris Vermeulen doesn't argue that gold would protect you in the event of a 50% market crash. Instead, he says that gold (and shares of gold miners) would crash along with stocks, and it would be a buying opportunity for investors. 

What Will Protect You In The Event Of A Market Crash

What will protect you in a market crash is put options on stocks. The standard objection to buying put options is that most of them expire worthless, and the cost of hedging with them can be a drag in an upmarket. That raises the question of what to do now, while the market is still going up. 

Buy What's Going Up And Hedge 

"Buy what's going up and hedge" is a bit of an oversimplification of our hedged portfolio method, but it's basically correct. We buy stuff that's going up, and looks like it might continue to go up, and we hedge in case it goes down instead. 

"How's That Working Out For You?"

Whenever someone presents a clever-sounding idea, it's natural to ask how that's working for them, as Brad Pitt's Tyler Durden does in the classic film Fight Club (1999). 

In our case, it's actually working out pretty well. Here's a real world example from six months ago. This was the hedged portfolio our site presented to an investor on October 5th of last year who was unwilling to risk a decline of more than 20% over the next six months. 

Screen captures via Portfolio Armor on 10/5/2023.

And here's how that portfolio did over the next six months, net of hedging and trading costs. This portfolio was up 50.65% over the next six months, versus up 22.62% for SPY. 

You can find an interactive version of that chart here. 

In that case, of course, the market went up, and our hedged portfolio did very well. What would have happened if the market had crashed by 50%? Since that portfolio was hedged against a >20% decline, it wouldn't have been down by more than 20%. 

Not a bad way to invest if you're worried about market crashes. 

 

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