The Good, the Bad, and the Ugly

Some things are really good in the economy right now, and some things are really bad.

The bad things:

• Auto loans are a mess, with 1.7 million cars getting repossessed this year.

• FHA loans are a mess, with the government yet to foreclose on most of them.

• Layoffs are starting, perhaps because of AI.

And meanwhile, we don’t have any economic statistics.

As for the “good,” stocks keep going up—or rather, a handful of stocks keep going up because earnings at big tech companies are absolutely eye-popping.

What are we to make of this economy? Well, I am not an economist, but it seems to me that AI capital expenditures are the last leg holding the economy up. Take away the AI, and we are in a recession.

This is not the first time this has happened in history—in fact, it happens pretty often, where there is a bubble in one thing or another while the rest of the economy is crap. The economic backdrop is an input to decision-making, but I do not trade economics. I trade sentiment. I trade based on feel about stocks. And how people feel about stocks is: Why do you need any bonds or anything else? Stocks go up 17% a year. It is a magic money machine. 

Having said all that, trading sentiment isn’t an exact science—it’s very possible that this continues for two more years to the point of absolute absurdity. So, how are you supposed to trade it?

Insurance

People get insurance on their houses, cars, and lives, but they don’t get insurance on their portfolios, which often is their most valuable asset. What do you need insurance for? Stocks go up all the time. My point exactly.

About 0.25% of houses will have a structural fire in any given year. That doesn’t mean a total loss, but about 1 in 400 homes will have a fire of some kind with damages. You wanna roll the dice? Throw in wind and hail and flood and everything else, and (I’m guessing) you’re up to about 1 in 100 homes that will have an insurable loss. Still want to roll the dice? If my new, big, beautiful house were to burn down, it would be financially catastrophic. You bet I want to protect that asset. But my portfolio is worth even more. I don’t want to be rolling around with no protection on my portfolio. But people do.

Some other statistics on things going bad:

• 35,000 people are killed in car accidents every year.

• 6,000 of those are texting while driving.

• 7,300 pedestrians are killed every year (I was almost one of them last year).

• 2,900 people are killed by hippos every year.

• 500 are killed by accidental gun discharges.

• 227,000 people die from all sorts of accidents.

• 2,000 people die from constipation (what a way to go).

• 1,500 people die from falling out of a tree.

• 1,100 people die from skateboarding.

• 1,000 people are killed by lawnmowers.

And you still don’t want life insurance? I have two life insurance policies—one big, one small. If you don’t have life insurance, you are not exactly the picture of your financial health.

So, we insure our houses and our lives but not our portfolios. Maybe it’s because there is no friendly insurance company out there with a green lizard or an emu that helps us do it. We have to figure it out on our own. Well, how you insure your portfolio is with options, and most people don’t know how to trade options. Basically, you buy a put option or options, or put spreads approximately equal to the notional value of your portfolio. If the market crashes, you will still lose some money, but you will be mostly protected.

I have done this successfully in the past, during the pandemic. I bought SPX puts a couple of months before the crash, and they paid off. Then, at the lows, I sold the puts and went long. Good times.

I have SPY puts right now, having bought them a few weeks ago. Here is how it works: If the market doesn’t crash, you lose the premium you paid on the put option, and your returns are reduced by a little bit. If the market does crash, a significant part of the losses is offset by the gains on the puts. You have to sell the puts, of course, which requires some market timing in the way that conventional insurance does not.

Anyway, I cover all this stuff in the Options Masterclass that was released about six months ago (that was very popular). And there are some arcane things to know, like the level of implied volatility, but all of that is explained in the masterclass.

Anyway, the point is that nobody sees the need to insure stocks right now, which probably means that it’s a great time to insure stocks. If the market goes down 30%, everyone will think it is a great time to insure stocks, which probably means it would be a bad time to insure a portfolio of stocks. In other words, insure when you can, not when you have to.

Thank you for listening to my public service announcement. You could, of course, sell all your stocks, but then you would have a tax liability, and then you would be completely out of the market. 

Look, I don’t like insurance companies, and I don’t like the idea of spending money on something I’m probably not going to need. In my lifetime, I have spent well over six figures on homeowners insurance. Never filed a single claim. Doesn’t mean it was a bad idea.

Jared Dillian, MFA