Top Hedge Fund Manager Sounds the Alarm on Market Risk. Here Are 4 Ways to Play a Possible Selloff

For the last few weeks, we’ve been talking about the risks piling up in the market. Like back in January, when we called valuations pornographic. To be honest, I was just repeating what hedge fund manager Doug Kass had written over on TheStreet Pro. But I agree with Kass’s take on the market. This isn’t a buy-and-hold kind of time. You’ve got to be careful when valuations are so high.

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Back in January, when the S&P 500 (SPX) was nearing its peak of 7002, Kass looked at valuations, debt, regulations, and the economy and found that the market was overvalued.

Since then, we’ve seen a bit of a break, with stocks off as much as 5%. Doug Kass is worried about a further decline. To be clear, he’s not calling for a major bear market just yet, but he is looking for a double-digit decline, which he spells out in “Feeling Like Michael Burry — Is the Market Finally Ready to Listen?”

It’s Not Easy Being a Bear. Even When You’re Right.

Many people are familiar with Michael Burry as the trader who called the 2008 financial crisis. His trades were memorialized in the movie, “The Big Short,” where Burry’s hedge fund rakes in $725 million from his aggressive shorts. What people don’t remember is that Burry was early. He’d been betting against the Subprime market for months before the break finally happened. His investors were furious, and Burry refused to let them take their capital out of his fund. 

Doug Kass feels the same today. He’s been worried for around 18 months as the stock market has moved higher. Now, Doug is a trader, so his long-term view informs his trades, but doesn’t control them. On the day that his Michael Burry article came out, the market opened down enough that Kass covered shorts and went long. He does that kind of thing. And he shares every one of those trades, in real-time on Doug’s Daily Diary. It’s amazing to see his many years of experience at work. 

If this is the kind of insight that can help your trading, I encourage you to join us over at TheStreet Pro.

Even though Kass went long on Monday, he’s still worried. He feels that investors have materially underpriced the following risks:

• Geopolitical risks are multiplying. The war in Iran is having impacts across the world and has already caused oil prices to spike. That puts a damper on economic growth. Plus, Kass has discussed that the Rule of Law, which has led to centuries of stability in the U.S., has been eroded. Investors are already pulling money out of the US.
• Slugflation lies ahead. This is Kass’ term for disappointing growth combined with persistent inflation.
• AI circular financing has become the norm for large AI projects but requires that these projects offer returns that may not materialize.
• Private equity and debt markets are deteriorating. Take a look at the charts of Apollo (APO), KKR (KKR), and Blackstone (BX), which are all at multi-year lows, around 50% below their all-time highs.
• Analysts have been way too optimistic about S&P Consensus Earnings. Their optimism is baked into the current valuation, which could spell trouble if companies begin to disappoint.
• Fiscal discipline is lacking in either political party.
• The Equity Risk Premium has become an Equity Risk Discount. Investors are treating normally safe bonds as if they’re the riskier asset class.

So, what’s an investor to do?

I asked Doug this question back in 2024, and he told me then to stay invested. Today, he’d tell me to take some risk off the table. Perhaps own less risky securities. Or even add some hedges. Perhaps in the form of a short ETF, or some well-considered shorts, which we’ll discuss below.

Nobody Ever Went Broke Taking a Profit

Chris Versace manages TheStreet Pro Portfolio actively, but the way that an investor would, rather than like a trader. The portfolio is designed to show you how you should react to the market’s gyrations. So, when Chris sells a beloved position or takes on a new one, he’s given it some thought.

On Monday, Chris locked in profits on coffee company Dutch Bros (BROS) because he’s worried that consumers will cut back on discretionary spending. After all, the February employment numbers were horrible, and people are spending most of their extra coffee money to fill up their SUVs. Versace detailed his rationale in “Exiting On Position and Initiating Another as We Become More Defensive.”

With the money Chris raised, he bought a hedge: the ProShares Short S&P 500 ETF (SH). SH is designed to trade opposite the S&P 500. When the S&P goes up by 1%, SH should lose 1%. When the S&P falls by 5%, SH should gain 5%.

So, with the approximately $180k Chris raised with the sale of BROS, Chris bought $120k in SH and left the rest in cash. That raises our cash position to 8.5% of the portfolio and gives Chris ammo to deploy when he finds good values. 

If you’re not familiar with TheStreet Pro’s Portfolio, Chris has a shopping list ready to go at all times. These are the stocks in his “Bullpen” and include names like Hershey (HSY) and IDEXX Laboratories (IDXX), which we’d discussed in this column before. Guess what else is on the shopping list: BROS. If the stock becomes a better value, Chris will buy it back. As they say, you won’t go broke taking a profit.

Back to SH. Chris didn’t go with an oversized position in this one. He’s keeping it to around 2% of the portfolio. It’s simply there to take the edge off any declines that happen.

Three Short Ideas for More Aggressive Traders

Bob Lang is one of TheStreet Pro’s technical analysts and options traders. Each week, he shares charts on stocks he thinks could have meaningful declines. Even in a bull market, there’s always something. The thing is, shorting stocks is hard. We share these bearish ideas for aggressive traders who might want to bet on declines in the stock prices, but also for investors who might own those shares. We want them to be aware of the risks so that they can take action.

This week, Lang covered three bearish ideas in “Ciena’s 1,000% Gain Come to an End: 3 Stocks to Short This Week.”

First, is Alaska Air (ALK). Lang says that bears have taken control of the airline stock as shares drop below the November lows. The Chaikin Money Flow is falling, showing that volume favors the downside.  From a momentum perspective, the RSI is in a steep downtrend while the MACD is on a strong sell signal, with the MACD below 0 and below its 9-day EMA.

Lang targets $36 and then below, if that price is penetrated. But if it goes against him, Bob would cover his shorts at $52.

It’s worth noting that the Wall Street analysts, who tend to be an optimistic lot, are bullish on ALK. The consensus has a $70 price target over the next year.

Next up is Ciena (CIEN). Ciena is a global networking systems, services, and software company specializing in high-speed optical networking, routing, and switching technologies. Lang points out that the stock is up nearly 1000% over the last year. His worry is that the stock dropped on big volume last week. Meanwhile, momentum has turned from bullish to bearish. The RSI fell out of overbought, while the MACD is rolling over from a very overbought level. 

Bob is looking for mean reversion on this one and thinks the 200-day SMA is a reasonable target, around $165. Tuesday was a big day for this one, and it broke above Bob’s stop level of $320. But I’m including it because the stock faded, attracting sellers at the end of the trading day. It’s worth a look, but not one to play in size because of its volatility.

Unlike ALK, analysts are mixed on this one. They believe the stock is fully valued here, and one thinks shares are only worth $240, 30% below Tuesday’s close.

Last up is Victoria’s Secret (VSCO), the specialty retailer. Shares dropped despite good earnings last week. Forward guidance was weak, and Lang thinks there’s more downside to come.

Technically, the MACD has been declining and is about to cross into bear signal territory. RSI, too, is dropping. Neither indicator is nearing oversold just yet. 

This is another mean reversion candidate, and Bob is looking for shares to touch the 200-day SMA around $35. But if the stock hits $60, he’ll know he’s wrong.

What do the analysts say? They’re more bullish than Lang. The consensus targets $65 and even the least optimistic thinks shares are worth 20% more than they’re currently trading for. But that only means there’s more fuel for the downward fire if Bob is right.

Final Thoughts

Shorting stocks is hard. If you’re right, the most you can make is 100%. If you’re wrong, your losses can be infinite. So, be careful. If you’re long these stocks, just take another look and be sure you’re comfortable holding something that may, even temporarily, go against you. If you’re a trader, then you know how to play from the short side. Just be careful.

And for more insights like this, please join us at TheStreet Pro.

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