May has seen some of the most volatile equity markets since January. The VIX, also known as the market’s “fear index”, hit its highest levels since the first week of 2019 this month.
Investors have a renewed concern over the US-China trade dispute as both parties add to the already hefty tariff schedule. With both sides playing hardball, investors are worried that this prolonged dispute will continue to give US companies grief. Global economic slowdowns are also a concern weighing on the markets and causing investors to contemplate whether the US is next.
In this article I will discuss some low to negative beta options to hedge anyone’s portfolio in these volatile times.
Chicago Mercantile Exchange CME
The CME Group is the largest commodity & derivatives exchange in the world. Based out of downtown Chicago, it offers firms a wide variety of derivatives and futures to hedge their business. The exchange is also used by speculative traders who believe they can beat the market.
As the markets have become increasingly volatile over the past month and the CME has shown investors an almost 10% gain while the S&P 500 is down roughly 5% since the beginning of May.
CME has a beta very close to zero making it a safer bet in rough market waters.
Most of the volume that is traded on the CME are interest rate derivatives, which are used to help businesses hedge floating interest rates, expected future borrowing as well as expected future lending. They also offer futures and options in equities, foreign exchange, agriculture, and commodities.
When the market breaks down companies tend to hedge more of their business due to the perceived future risk associated with a market downturn. Speculative traders on the CME exchange are also trading larger volumes because of the increased volatility, something every day trader is waiting for.
The CME Group’s revenue is driven almost entirely by volume and as the markets break volumes increase for the reasons mentioned above.
Volume has consistently increased over the past 5 years by an average annual rate of 9%. CME Globex has primarily driven this growth. This is CME’s online platform that makes it easier for any business to hedge, no matter the size. The past 5 years have been relatively low volatility, so when the markets hit the fan expect CME to reap the benefits
CME is currently trading just off its 10-year forward P/E high. I would wait to put a long position on CME until the valuation comes down a bit. Look to buy once CME drops below the $180 level. This low beta exchange is expanding and will make not only a good hedge but also an excellent long term investment at the right price.
AngloGold Ashanti Limited AU
Gold prices have an inverse relationship with the equity market because of its flight-to-quality characteristics. As you might guess, gold miners and gold move together.
AU has a beta of -1, implying that it will show investors returns when the broader equity market isn’t. You can see this inverse relationship play out in this past month, as AU attains 8% returns and the S&P 500 slides almost 5%.
AU is trading at favorable multiples, with its forward P/E of 11.2x below its 10-year median and far below the gold mining industry average (north of 30x). If you factor expected growth into its P/E multiple the investment looks even more attractive, trading at a PEG of 0.6x, significantly below the industry average of 5x.
AngloGold Ashanti is expected to grow its EPS by 90% this year and 21% in 2020. Analysts have raised these estimates considerably over the past 2 months thrusting AU to a Zacks Rank #1 (Strong Buy).
Pinnacle West Capital PNW
Investors often use utility companies as investment safe-havens because of their consistent cash flows and large dividend payouts. Falling interest rates, which we have been seeing, are also good for utility companies because of the capital intensive nature of their business causing them to carry a lot of debt on their balance sheet. Historically during market downturns, utility stocks have outperformed the broader equity market.
Pinnacle West Capital is a utility holding company whose subsidiaries provide Arizona with electricity. PNW is responsible for generating and distributing electricity to 1.2 million customers around the Phoenix area.
PNW is focusing on expanding its customer base and updating its infrastructure with renewable energy being a focal point. They are planning on investing roughly $4 billion over the next 3 years in order to make this happen.
Over the past decade, PNW has consistently grown its top and bottom lines as well as expand its margins, something most utility companies can’t boast. PNW has performed exceptionally well over past 52-week, returning investors over 20%, and outperforming both the industry average and the S&P 500.
Analysts are have raised long term EPS outlook for PNW over the last 60 days propelling this stock into a Zacks Rank #2 (Buy).
An expanding utility company that still pays out a dividend north of 3% is hard to come by. PNW is about 5% off its all-time high, which it hit last week, and I believe now is the perfect time to add this low beta utility company to your portfolio.
Market volatility is inevitable and the best way to protect your portfolio from exacerbated losses is to hedge it with low to negative beta options. You could use a growing exchange like CME for long term portfolio returns combined with a low beta hedge (at the right price). AU and other gold mining stocks with a negative correlation to the market will allow your portfolio to have some profitability even in the worst downturns. A utility company like PNW will give your portfolio sustainable yields and even some long term growth without adding to your market exposure.
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