U.S. stocks rallied on Friday. The Dow rose 1.7% to 11628.06. The broader S&P’s 500 climbed 1.1% to close at 1292.20. The Nasdaq closed 1.4% higher at 2414.71.

For the week, however, the Dow shed 0.3%. The index has now closed down four out of the last five weeks.

So what are investors to make of U.S. stocks? David Newman in The Sovereign Society says you can’t trust this kind of market for long. We’re in a secular bear market. That means a lot more pain for your portfolio if you don’t hedge your investments carefully…

It all goes back to the United States’ fundamentals. You have to ask yourself: What’s really changed since stocks started rallying last month?

Are the banks suddenly safe? How about the airlines, autos, homebuilders, insurance companies, and restaurants? Are consumers finally spending money again? Did everyone take their nice allowance checks from Dear Old Uncle Sam and go buy designer luggage, expensive Armani suits, new fishing gear or finance their weekend getaways?

(Answer: “Not really” - at least not enough to show a significant recovery.)

Have Freddie and Fannie suddenly made a miraculous recovery? Did Paulson’s magical words somehow heal years of Freddie and Fannie’s bad sub-prime loans?

(Answer: Not even close.)

Did the Fed heal entire financial system with their masterfully slashed interest rates and the ability to hold rates steady for months at a time?

(Answer: Nope, but good try Mr. Bernanke.)

Also, it’s no secret that stocks rally months before a market actually bottoms. Stocks anticipate a recovery long before we actually see one.

No, in my opinion, we’re all going to chew on a few more rolls of Rolaids before this bear is really laid to rest.

Need proof? All you have to do is pick up any newspaper, turn on any TV station, tune into the radio or log on to the Internet, and you’ll find your evidence. In fact, I’ll bet you can’t go more then 30 minutes before you hear or read something like this…

“Fannie Mae, Freddie Mac shares plummet”

“Shares of mortgage finance companies Fannie Mae and Freddie Mac continued their plunge Wednesday (Aug 20, 2008) as investors became increasingly convinced that the stocks will drop to zero if the government bails out the troubled companies.”

The Big Whopper of a Bank is Going Under Next

And this came across the wires earlier this week too…

“Kenneth Rogoff, the former chief economist of the International Monetary Fund, reportedly said Tuesday that a large U.S. bank will collapse in the next few months. We’re not just going to see mid-sized banks go under in the next few months, we’re going to see a whopper, we’re going to see a big one, one of the big investment banks or big banks.”

Did you hear that? It’s not just the small Mom and Pop banks or even medium-sized banks that are in trouble. They’re predicting the huge category five storm is going to hit one of the biggest banks in the market. It’s just a question of which one…

And what about the homebuilders? Homebuilding was the first sector to fall apart when this uncomfortable bear market started to appear last summer. And you know what they say: “First in, first out…” So homebuilders should be improving right?

Wrong. How’s this for a headline?

“Foreclosures smack home prices - down 29.3%”

— San Francisco Chronicle, Aug 20, 2008

Meanwhile, mortgage applications just hit a six-year low. The Mortgage Bankers Association says it will take nearly 12 months to finally sell all the homes still sitting in the market.

Also, constructions plans, which indicate bigger building projects on the horizon, plummeted 32.4% since this time last year.

In other words, we need to build houses to help pull us out of this recession yet if we do, we’ll increase inventory, depress prices and accelerate this snowball. How’s that for a double-edged sword?

To recap, we’re staring at bleeding sectors, more possible bank failures, a hemorrhaging housing market in a recession, and politicians who have NOT managed to fix the fundamental problems yet.

So is a little stock rally really supposed to make us happy? Not hardly.

Your Market Insurance While the Economy Heals

So what are your options when a crazy bear market rears its ugly head?

When the markets are this uncertain, one of my favorite strategies is investing with an ‘insurance policy.’ Let me explain. An insurance policy can be as simple as a buying both a beaten-down stock and a put option betting against it in the same sector.

This way if the sector starts to bleed once more, your put option hedges your position. On the other hand, if the stock rises, you’ll more than recoup the money you invested in your “insurance policy put.”

Let me give you an example and one I’ve recently used. A few weeks ago I thought that the financial sector may have hit at least a temporary bottom. So I recommended buying an ETF on the financial sector to our Sovereign Society members in The Sovereign Individual.

That’s a fairly risky bet when the banks still need some time to dig themselves out of this hole. So I hedged the risk by recommending members buy one near the money put option, out about 3 months, for every 100 shares of the ETF. The option cost about 8% of trade.

We call this a paired trade.

If the financial sector rebounds, this ETF take off and members will grab 92% of the gain. If the sector crashes everyone has the put option to soften the blow.

The same strategy can work for you. Hedge your bets and we’ll all make it out of this bear market without too many hits…

Source: Is the Bear Hibernating Already? I Doubt It.