Montreal, Canada

Bulls and bears should both embrace portfolio hedging ahead of the next correction or panic. Learning how to apply a hedge or a series of hedges can mitigate market risk while protecting portfolios. That's especially true today with stocks in the midst of their greatest rally in more than 100 years.

In late September 2008 I turned my European-based mutual funds and managed accounts from almost market-neutral to net short using reverse-index funds or exchange-traded-funds. For dollar-based accounts, I bought SH, the Pro Shares Short S&P 500 Index, in New York and for EUR-based accounts the Frankfurt-listed DB X-Trackers Short DAX ETF. Both positions surged more than 20% in Q4 when world markets plunged about 22%.

Without employing reverse index ETFs last year my portfolios would have declined much more. Just how badly did I fare? Insurance-related funds declined 7.8% after all fees and managed accounts fell an average 4.8% in 2009. Not bad. This compares to a hefty 38.5% plunge for the S&P 500 Index, -40% for the MSCI World Index and -20% for the CSFB Tremont Hedge Fund Index.

Still, I'm bearish in 2009 and have failed to participate in this rally.

I was net short heading into March and then reduced my hedges ahead of the explosive rally; the only long positions I bought in March were convertible bonds. I sold my reverse index ETFs the first week of March. Still, my equity exposure has remained the lowest in ten years and I'm about flat this year versus a 25% gain for the MSCI World Index.

Since August, I've raised my long positions in stocks only slightly while remaining hedged. I anticipate buying more reverse-index ETFs as stocks climb even higher. There's still an avalanche of money sitting in cash, tempted to join this spectacular rally.

Reverse-index ETFs now trade at 52-week lows and offer a great entry point for investors looking to protect their stock positions – we all know this rally won't last.

Corporate earnings aren't supported by revenue growth and, for the most part, have benefited from cost-cutting and accounting changes since May. Consumer sentiment has declined for two months in a row (September and October) despite a stock market bounce. Stocks don't even react to bad economic news anymore.

In the absence of organic domestic consumption the government can't replace consumer spending indefinitely; the global economy is recovering yet $80 oil doesn't help to boost spending in a world still fractured by the loss of credit intermediation, rising unemployment and falling wages.

This is the Mother of all bear market rallies. Hedging your portfolio now is inexpensive and the wisest strategy ahead of 2010.