Derivatives and shorting are a lesser-understood tools getting more shine in the current bear market
The share market rally seen through the early years of the pandemic is well and truly over and defence, rather than growth, is the name of the game. Should investors be looking at shorting?
The S&P NZX 50 index, a bellwether for the New Zealand stock market, is down around 14 percent in the year and down around 18 percent on the all-time high seen in January 2021.
America’s stock markets have also peaked for the year in January and have been consistently down since.
CMC market analyst Tina Teng said New Zealand’s market might underperform global equity markets because of the Reserve Bank’s hawkish monetary policy stance, as opposed to a “peak of hawkish” view held by the US Federal Reserve and the Reserve Bank of Australia.
The peak of hawkish approach seen overseas contains more for investors to be confident about – the Fed has signalled it will slow down rate hikes and in China, Covid measures are being relaxed and its central bank has signalled it will cut its reserve requirement ratio for banks.
While some others are moving to stimulate their economies, New Zealand’s central bank is engineering a recession to get inflation back into its target band.
It expects rate hikes to peak next year with a recession from June.
“It’s not only New Zealand; a global economic recession may also not be avoidable in the next one or two years due to all the above-mentioned negatives as bond yield curves flattened, which may indicate that a rate cut will be significant and swift if recession happens, like what happened during the pandemic and the 2008 GFC.”
She said this suggested the current market decline hadn’t bottomed out yet.
Traditional hot stocks in such markets are stable consumer staples such as healthcare and utilities, with energy companies particularly attractive this time around – amongst a sea of red, the S&P NZX all energy index is up 40.26 percent in the year.
These defensive stocks don’t offer investors the gains seen by riskier stocks in upwards markets but provide stable earnings.
How do you tap ‘growth’ in a downward market?
Contracts for difference, or CFD, allow you to trade on the price movement of financial assets without actually owning them, meaning you can tap growth in a downwards market if you’re that way inclined.
“CFD could be used at any market’s conditions but in the current bear market, it will give clients easy access to short the markets as it is a two-sided trading tool. For example, you could short sell an instrument that is in its downtrend to gain profit from the price’s drop.”
It can also be used to hedge long-term positions or access volatility in currency.
Losses and gains can be magnified by trading on margin, where you only deposit a small percentage in order to open a position but the leveraged trade is based on the full value.
Shorting really came into popular consciousness through the GameStop saga last year, coinciding with the rise of the day trader through the pandemic.
Although they took a stand against institutional shorting practices through GameStop, day traders focus on short-term trading rather than the traditional retail investor’s value-based buy and hold approach making CFD’s a particularly useful tool.
