What Goes Up When Stocks Go Down? The 1929 stock market crash ushered in the Great Depression, and for the next 12 years, the entire western world was under tremendous financial pressure.
While subsequent crashes weren’t quite as bad, those who saw their portfolios bottom out in 1987 and 2008 certainly suffered substantial losses.
Considering the 2008 financial crisis developed into a global event, by some measures it might be said that the total impact was far worse than previous market catastrophes.
There are a few investors who always come out on top, no matter what happens in the market. During the Great Depression, it was Michael Cullen, who came up with the concept of a suburban supermarket.
J. Paul Getty launched what would become the Getty Oil conglomerate that made him a billionaire, and Charles Darrow made the most of his unemployment by inventing Monopoly, a board game that went on to generate millions.
Perhaps most remarkable of all, the Great Depression set the stage for one of America’s most notable families to prosper. Joe Kennedy, Sr., John F. Kennedy’s father, built a fortune through smart investing during this period.
During the Great Recession that followed the 2008 financial crisis, the winners were investment experts like Berkshire Hathaway CEO Warren Buffett, hedge fund manager John Paulson, and legendary businessman Carl Icahn. All managed to come through the market crash with their portfolios stronger than ever.
What is their secret to finding financial success when the rest of the world is failing? Is it as simple as diversification? Certainly, these investment masters balanced their portfolios in a way that ensured when one asset went down in value, another rose. As a result, they had enough cash on hand to continue investing when prices were at rock bottom. As the market recovered, which historically it always has, they were perfectly poised to profit.
How can you create a diversified portfolio that will withstand changing market conditions? First, learn what goes up when stocks go down, then select the asset mix that best meets your financial goals.
Volatility Rises When Stocks Fall
As you know from basic economics, pricing depends on supply and demand. When there is more of something available than people want to buy, the price goes down. When there isn’t enough for everyone, the price goes up. Stocks work in just the same way, with prices fluctuating based on the number of people who want to buy versus shares available for sale.
Volatility is a measure of how quickly stock prices move and how dramatic the changes are. A stock that rises by double digits then abruptly drops below the original price is highly volatile, while one that increases slowly and steadily has low volatility.
High volatility points to investments with high risks and correspondingly high potential rewards, while low volatility points to safer, more reliable – but less profitable – options.
The Chicago Board Options Exchange studied this phenomenon in great detail, eventually developing a Volatility Index (VIX) to measure the volatility and corresponding investor risk of the market as a whole.
It uses historical data and current events to forecast market volatility 30 days out, which offers investors a peek at the market’s future. When the stock market goes down, volatility generally goes up, which could be a profitable bet for those willing to take risks.
Though you can’t invest in VIX directly, products have been developed to make it possible for you to profit from increased market volatility.
One of the first was the VXX exchange-traded note. Launched in 2009, this product gave investors the opportunity to bet on the size of market swings. It was popular among individuals as well as fund managers, because it offset some of the risks associated with a market downturn and added a new level of diversification to portfolios.
VXX expired January 30, 2019, but you can still participate in this sort of investment through Barclay’s iPath Series B S&P 500 VIX Short Term Futures ETN (VXXB). VXXB was launched in 2018 with a 30-year maturity date, and it now trades under the original VXX symbol.
Put Options Increase in Value
Once you are comfortable with buying and selling stock, the next step is to explore options trading.
Options contracts give you the right – but not the obligation – to buy or sell an underlying asset at an agreed-upon price.
Call options are those that give you the right to buy the underlying asset at a specific price, and put options give you the right to sell the underlying asset at a specific price.
Adding put options to your portfolio may offer some protection against a sudden downturn in the market, because they increase in value as the price of the underlying asset decreases. This is particularly helpful in managing your risk when you have put options on index funds. Examples include the following:
- SPDR S&P 500 ETF Trust (SPY) – Tracks the S&P 500 market index, which benchmarks large market cap stocks.
- Diamonds ETF (DIA) – Tracks the Dow Jones Industrial Average (DJIA) index, which measures stock price movements for 30 large American companies.
- Russell 2000 Index (RUT) – Tracks the 2,000 smallest-cap American companies in the Russell 3000 Index.
These funds are designed to produce returns similar to the underlying market index, so share values decrease in a market downturn.
If you have put options, you can sell shares at more than their market value, which allows you to profit despite falling stock prices.
Inverse ETFs Rise When Stocks Fall
Diversifying your portfolio with a variety of assets that respond to market conditions in different ways is fundamental to reducing your risk. Some products take on the challenge directly.
Inverse ETFs are specifically designed to rise and fall at an equal but opposite rate as compared to the underlying index. For example, if an inverse ETF is based on the S&P 500 index, a 1 percent increase in the S&P 500 should result in a 1 percent decrease in the ETF’s value – and vice versa.
Examples of popular choices include the following:
- ProShares Short S&P 500 (SH) – This ETF uses the S&P 500 as its benchmark, and it offers investors an opportunity to profit if the market declines.
- ProShares UltraPro Short QQQ ETF (SQQQ) – The UltraPro Short QQQ ETF is intended as a short-term hedge for investors who expect an imminent decline in market conditions. Specifically, it is a three-times leveraged inverse ETF that focuses on the Nasdaq 100. This index measures the performance of the largest organizations trading on the Nasdaq, both in the US and around the world, however it excludes financial institutions. The ETF’s goal is to return the exact inverse of Nasdaq 100 results multiplied by three.
- ProShares UltraShort S&P500 (SDS) – This ETF also focuses on the S&P 500, with a goal of producing daily investment results that are twice the inverse of the S&P 500’s performance. These results are calculated before fees and expenses.
- ProShares UltraPro Short S&P 500 ETF (SPXU) – Like SDS, this ETF is intended to track the S&P 500. However, the goal is to generate daily investment returns that are 3 times the inverse of the S&P 500.
Inverse ETFs offer a straightforward hedge against the possibility of a sudden market downturn. However, such investments are risky and complex, so they aren’t recommended for everyone.
If you choose to test the waters with these sorts of assets, make sure you understand your exposure to derivatives securities risk, correlation risk, compounding risk, and short sale exposure risk before you buy.
Safe Haven Assets
Some investments are deliberately developed to create gains when the market loses. Others have a naturally inverse relationship with stocks – or no relationship at all.
Adding these assets to a portfolio is the most common way to mitigate the risk of losses due to a declining stock market. In times of economic uncertainty, many investors move money out of high risk assets and into these alternatives, earning them the name “Safe Haven” assets.
Examples of Safe Haven assets include the following:
- US Treasuries – Also known as T-Bills, these debt securities are guaranteed by the US government. As such, they are considered almost risk-free, which is a nice position to be in when the stock market is losing money.
- Gold – This precious metal has been considered a store of value for generations, and many investors feel more comfortable when their wealth depends on an asset they can see and touch versus paper currency, which has no intrinsic value. Gold isn’t affected when government agencies change interest rates, so it tends to hold or increase in value when the stock market drops.
- Bitcoin – Believe it or not, some investors are turning to cryptocurrency as a temporary place to hold money when the market seems uncertain. Whether this trend will develop into a mainstream strategy remains to be seen.
Of course, all of these Safe Haven assets do carry risks of their own. US Treasuries don’t offer the returns necessary to offset inflation, and Bitcoin has had its own struggle with volatility.
For some investors, these assets may be better thought of as temporary solutions during an economic downturn, rather than a long-term investment option.
Stocks That Rose in Last Recession
Though there are times when the stock market as a whole is in trouble, that doesn’t mean every company is losing money. A variety of businesses – and even entire industries – thrive during an economic crisis.
As a general rule, you can count on solid revenues from companies that compete on pricing. When money is tight, consumers accustomed to purchasing mid-range products will downgrade to less expensive options.
During the Great Recession, these five stocks didn’t suffer the same fate as the larger market. In fact, they turned a tidy profit while many other businesses failed.
Keep an eye out for opportunities like this when your stock portfolio starts to lose money.
Bonds Often Rise When Stocks Fall
Finally, no list of risk mitigation opportunities would be complete without a note about bonds. As you are sure to have noticed, every financial advisor recommends adding bonds to your portfolio in various proportions, depending on your financial goals.
Bonds often rise when stocks fall, which ensures that your investment is somewhat protected against dramatic market downturns. In retirement portfolios, these assets play a larger role as your retirement age draws closer, so that the income you need is there when you are ready to leave the workforce.
The bottom line is that you don’t have to leave your portfolio open to the whims of the market. There are specific assets that go up when stocks go down, mitigating your risk.
The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.