After stumbling in November, markets face two final hurdles before year end, first on Dec 15 at the final Fed meeting of the year and second when government funds are projected to dry up by Dec 21 absent further action from Congress to extend the US debt ceiling. While debate over this ever-rising “ceiling” has become an annual political sham that invariably ends with more debt, it nonetheless carries a risk of extreme outcomes that must be factored by markets.

Corrections (declines of less than 5%) are a fact of life in equity markets. They are irrelevant to long term outcomes and very expensive to protect against, yet they still preoccupy investors and the financial industry that caters to them. In our experience, it also seems to be true that the longer markets rise, the more sensitive investors become to corrections. Despite this psychology, the mathematical fact remains that less frequent large declines are the true risk to compound returns, and it is these periods that our approach seeks to address.

As of Sept 30, the S&P 500 is less than 5% off all time highs awaiting a catalyst to either end the correction or push markets closer to a true crisis. Heading into the historically volatile 4th quarter (see below), a few possible candidates are converging in October including the expected tapering of bond purchases by the Federal Reserve and political showdowns over the US debt ceiling and the multi-trillion dollar US infrastructure bill.

Effectively hedging portfolios is a challenging task that involves a careful weighing of tradeoffs. Dedicated hedges can cushion a portfolio during times of stress, but they also tend to lose value quickly while markets rise. Low-correlation exposures such as Alpha Seeker have the ability to profit regardless of the direction of broad markets, but may not be perfectly anti-correlated during every market decline. With the right vehicles in the right combination, it may be possible to construct an exposure that retains most of the benefits of hedges while greatly reducing their cost.

Presently, VIX prices remain mostly higher than would normally be expected for a quiet equity market near all-time highs. So far, this has just been been another “wall of worry” for stocks to climb, but with the historically turbulent fall season and the Fed’s Jackson Hole symposium approaching, a change could be in store.