US Stocks Suffered a 'Black Wednesday': How to Hedge Risks in Market Turbulence?

The trigger for the comprehensive stock market crash is multifaceted. On the one hand, the poor financial performance of Tesla and Google has raised concerns about the tech stock valuation bubble and the money-making ability of AI. The narrative of AI, which previously supported the market surge has also been questioned, leading to the accelerated withdrawal of funds from large-cap tech stocks and a market collapse. Meanwhile, the release of the US July Markit Manufacturing PMI preliminary reading, which unexpectedly contracted to a seven-month low, has reignited concerns about a potential economic recession.

Looking back at the last earnings season, Tesla surged 12% despite Q1 earnings falling short of expectations. At that time, all Elon Musk had to do was paint a positive vision, announce the launch of a new affordable model, emphasize Tesla's AI capabilities, and promise to release Robotaxi later in the year, which restored market confidence. However, this time is different. Musk's story about autonomous driving failed to save the underperforming financial results, with the double-digit decline in earnings per share and the less-than-15% gross profit margin in the automotive business exacerbating the sell-off. This not only reflects investors' renewed focus on profitability and fundamentals but also highlights the fragility of the current high-valuation tech stock sentiment.

As more and more tech stocks release their earnings reports next week, market uncertainty remains significant, and the fragile sentiment around the tech stock valuation may continue to spread. Moreover, considering the high concentration of tech stocks in the S&P 500, even if funds flow into other safer sectors, it will be challenging to maintain an upward trend in the overall index in the short term.

Despite the yield curve inversion lasting for two years, the market has not yet seen a real economic recession, which has caused investors to question whether this most common recession indicator is malfunctioning. However, more and more clues indicate that the risk of a slowdown in the US economy is increasing.

In June, the US non-farm payroll employment growth rate fell sharply, and the unemployment rate rose to 4.1%, the highest level in two and a half years. Corporate recruitment activities have also significantly cooled down. Citigroup's latest research indicates that the current US economy may be at a turning point, and if the labor market continues to be weak, it may trigger recession warnings from economists. The market is eagerly awaiting the latest clues on the labor market dynamics from Thursday's initial jobless claims report, confirming whether the recent labor weakness is seasonal or the beginning of an economic slowdown.

The US July Markit manufacturing PMI was only 49.5, hitting a 7-month low, indicating that manufacturing has once again entered a contraction phase. The report suggests that the uncertainty brought by the US presidential election has exacerbated the restraint on investment and recruitment. At the same time, due to high mortgage rates and house prices, US new home sales fell for the second consecutive month in June, unexpectedly hitting a seven-month low, further deepening concerns about the US economic slowdown.

In addition, the recent continuous decline of the copper-gold ratio, which fell by more than 8% this month, has also released a warning signal. Generally speaking, when the economic situation slows down or enters a recession phase, the demand for copper decreases, and the demand for gold hedging increases. Copper's weaker performance compared to gold leads to a decline in the copper-gold ratio. Moreover, historical experience shows that the copper-gold ratio leads the EPS growth rate of the S&P 500 companies by an average of five months, and a significant decline in the copper-gold ratio may also indicate that the company's profit situation will soon face challenges.

Given that the annualized quarterly growth rate of the US real GDP for Q1 was revised down from the initial estimate of 1.6% to 1.3%, a significant slowdown from the 3.4% growth rate in Q4 of last year, the market is closely watching the release of Q2 GDP figures on Thursday. This is because the common experience suggests that two consecutive quarters of GDP contraction indicate an economic recession.

In addition to the disruptions caused by earnings season and economic recession concerns, the election year and Biden's withdrawal have added to market uncertainty. Historically, the VIX index tends to rise in the months leading up to the US presidential election. This has further intensified the market's wait-and-see sentiment.

1. Option Hedging: Based on different judgments on the depth of market decline and volatility, investors can choose various option strategies to hedge their position risks, including:

● Covered Call: Investors can sell call options to receive premiums while holding stocks. Although this can hedge the downside risk of the underlying stock by collecting options premiums during small stock fluctuations or when no significant upside is expected, investors may lose potential profits if the market experiences a significant rebound and the option is exercised. In addition, this strategy provides limited protection during significant market downturns.

● Protective Put: Investors can protect their existing investments by purchasing put options while holding stocks. This limits the losses during a downturn while retaining the potential gains from stock appreciation. However, investors need to pay attention to the critical cost of options premiums.

● Collar: Investors can buy puts and sell calls to lower costs while holding stocks. This combines the advantages of protective put options and selling call options, providing downside protection and generating additional income. However, if the stock rises significantly, the sold call options may limit profits, and if the stock falls, the cost of the purchased put options needs to be paid.

4. Diversification of investments and seeking opportunities outside of the US market: Cryptocurrencies, gold, and short-term Treasuries can also serve as diversified investment options, increasing portfolio diversification while hedging against risks.