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2 Bear market leaves short
options By Julian Delasantellis
Frequently, with my
reputation as something of a Gloomy Gus economic
prognosticator well established, people write to
me, sometimes in near desperation, wanting advice
on what to do with their investments, their
finances, the money they're saving for their kids’
education or retirement. On those occasions, I
sympathize with these sentiments, from the theme
song of the movie and TV show MASH, "Suicide is Painless." A
brave man once requested me to answer questions
that are key is it to be or not to be and I
replied 'oh why ask me?’
Now before you
run off and tell everyone that I now see things
are so bad that I’m currently recommending suicide
as a portfolio choice, let me tell you that I
chose that song as an illustration as
to how seriously I take
such questions. Everybody's situation is
different; any advice given to a 25-year-old
should differ from that proffered to a
65-year-old. Also, as a trader, my time horizon is
usually much shorter than that of straight (and, I
suppose, gay ones as well) investors; ask me where
I think the dollar is headed against the euro or
yen, I’ll give you an answer - what I think is
going to happen in the next half hour or so.
But some advice I feel comfortable in
giving most all of you is this: whatever your
current perspective or outlook on the markets,
informed usage of what are called ETFs, for
Exchange Traded Funds, should be part of almost
all of your strategies.
The business
school definition of ETFs introduces more
confusion and gobbledygook than is really
necessary to understand this phenomenon, but, for
those gluttons for punishment, here it is.
According to the most excellent Investopedia web
site, an ETF is "a security that tracks an index,
a commodity or a basket of assets like an index
fund, but trades like a stock on an exchange, thus
experiencing price changes throughout the day as
it is bought and sold."
What's really
being said here is that ETFs are very valuable
hybrids, combining the best features of individual
stock ownership with that of owning many mutual
funds, especially index mutual funds.
Many
of you already know of ETFs in the context of
being cognizant of trading instruments such as the
QQQQ or the SPY, the ETFs that track the prices of
broad indexes such as the NASDAQ 100 or S&P
500. If you thought that the general market
represented by these indexes was going to go up,
or go down, but did not know how to, or care to
take the time to analyze individual stocks you
could buy (or, in the case of a bearish
perspective, sell short) these, and other like
structured ETFs to profit if you are correct in
your call of the general trend of the market.
Of course, you could do the same with a
stock index fund from a mutual fund company, but
ETFs have many very distinct benefits from index
mutual funds.
Index mutual funds allow you
to take only one view of the market - bullish. You
can’t attempt to profit from down moves through a
"short" sale, but this is allowed with ETFs. Also,
you cannot trade index mutual funds on an intraday
basis. If you have a day in the markets such as
last August 16, or January 22 and 23 of this year,
when the US stock markets opened very weak, and
then surged higher at the end of the day, an index
mutual fund would only give you that higher, end
of the day price.
In many cases, by having
to buy in at the high end of the day’s price, you
could be missing much, or most of the up move.
ETFs can be bought or sold throughout the trading
day; if you were watching the markets closely on
the above referenced days (if you didn’t have a
real job for example) and if you were very quick
and clever, you could have bought ETFs at the
bottom, and have made substantial profits in just
the brief time period between your purchase and
that day’s close of trading (none of that
"investing for the long term" nonsense implied
here).
Also, if you really want to play
this game pedal to the metal, if you hunger for
risk and danger the way a child does with candy or
George W Bush does with catastrophe, ETFs can be
bought or sold on margin, something very hard to
do with most mutual fund families.
It is
also true that transaction fees, such as brokers’
costs, what you pay to buy and sell, are usually
far lower with ETFs than with mutual funds,
especially if you are a frequent trader. And, of
course, ETFs are available for trading by non-US
investors, just like any other stock market
listing.
Like much in modern finance, ETFs
originated in the efficient markets hypothesis
(EMH) that swept through academic research and
thought on finance and markets in the late 1960s
and early 1970s. The primary proponents of the
theory were Eugene Fama, in his 1965 doctoral
dissertation at the University of Chicago Business
School, and Princeton Professor Burton Malkiel,
who popularized the theory in his 1973 book, A
Random Walk Down Wall Street.
Basically, what Fama, Malkiel and others
were saying was that all those long hours that
amateur investors were spending back then, with a
slide rule and/or mechanical adding machine, the
stock tables pages of the local paper (for back
then even small local papers had comprehensive
stock tables; before the full impact of American
suburban sprawl made timely delivery impossible,
many even came out with afternoon editions with
closing stock prices) sprawled across the kitchen
table before them, were nothing but a waste of
time.
No investor, no matter how many
fancy degree initials he had on his business card,
could expect to generate returns, be more
profitable, than the average market indexes; to
attempt to do so would be like building a career
based on your confidence in consistently
predicting the results of a coin flip. The
recommendation inherent in this theory was to
clean off the kitchen table (I suppose that would
also cut back on divorce lawyer costs as well) and
just buy a broad basket of stocks whose movements
represented the general market trends.
OK,
how are you going to do that? Prior to the
deregulation of fixed broker’s commissions in
1975, stock trading was a far more expensive
proposition than it is now; just sending in buy
orders for the 30 stocks of the Dow Jones
Industrial Average could set you back over
US$2,000; (by comparison, median US family income
in 1970 was just under $10,000) imagine doing that
for the 500 stocks of the broader, more
representative of the general market stocks of the
S&P 500.
Was the wisdom of Fama and
Malkiel only to be available to those big traders
and investment accounts who could afford to
negotiate more reasonable commissions from the
brokerage houses?
It was Wells Fargo and
American National Bank who established the first
actual stock index fund, the Standard & Poor's
Composite Index Funds, for institutional
investors, in 1973. Legendary investor John Bogle
started the first index mutual fund for individual
investors, the First Index Investment Trust, at
the end of 1975; at the time some, probably those
traditional brokerage houses who had grown fat and
sloppy from the lack of real competition, derided
this development as "un-American".
In
1982, the Chicago Mercantile Exchange (CME)
futures exchange introduced the S&P 500 index
futures contract, but this instrument’s high
margin requirements, and the generally more
complicated nature of a futures contract as
compared to a stock or mutual fund product, also
made this overwhelmingly a vehicle for
professional, full-time, not amateur part-time,
investors and speculators.
The American
and Philadelphia Stock Exchanges tried to
introduce and market index ETFs in 1989, but were
forced to withdraw their product under legal
pressure from the CME. The American Stock Exchange
(AMEX) was more successful in 1993, with its
introduction of the first Standard & Poors’
Depository Receipts (SPDRs), the SPY, still one of
the most popular and heavily traded ETFs in the
world. Others followed. According to the
Investment Company Institute, by February 2008
there were 634 ETFs registered in the United
States, up 46% from the previous February. In a
difficult year for stock investing, the total
assets of ETFs, at $559 billion, were up 29% in
the same period.
But very few of these 634
ETFs now follow the straight EMF paradigm of
general market indexing. The concept of the ETF
product has branched out into some very
interesting directions these days.
For one
thing, the model of index investing has moved well
beyond the most popularly known indices such as
the NASDAQ and the S&P 500. The EMHs’ academic
proponents and researchers extended the theory to
include sub-indexes of the major indexes; thus, if
you could assemble an index of just pharmaceutical
company stocks, the theory said that no one could
reasonably expect to consistently beat the returns
of that index through picking and trading just the
individual stocks of the pharmaceutical companies
(see Of termites and index
mania, Asia Times Online, July 3,
2007).
Thus, specialized sub indexes were
developed to track individual sectors of the
market, and from this came ETFs devoted to
tracking the returns of these sectors, and thus
making low-cost investment across the range of the
sector very easy.
With the world food
shortage now moving into such a prominence that it
soon may make global warming seem like a day at
the beach (ha ha), you may be interested in the
Market Vectors Global Agribusiness ETF, ticker
symbol (and this is not a joke) MOO. This fund is
up over 13% this year to date, as opposed to the
S&P 500s decline of about 5%.
Do you
think that, with gas so expensive these days,
people are just going to be staying home all day
surfing the web? (Don’t laugh - that actually was
an argument used to justify the dot.com mania of
the late '90s.) Then you might be interested in
the Internet HOLDRS ETF, ticker symbol HHH,
comprised of companies such as Yahoo and Ebay.
This ETF is down about 2.5% year to date; maybe
its problem is that you have to have a home to be
able to surf the net from it, and for hundreds of
thousands of Americans these days, that’s an
increasingly problematical situation.
Think John McCain’s going to win? Then you
might want to look at the Powershares Aerospace
and Defense Portfolio, ticker symbol PPA. Although
this fund is down over 13% this year, you just
know that if a Republican holds on to the White
House this November the interests of the people
will take precedence, just as long as those people
spend a lot of time in the boardrooms of the
military-industrial complex. Then again, if the
Democrats do actually unify and pick a viable
candidate (stranger things have happened, although
right now I really can’t think of one) PPA might
be a good short.
There’s a wide selection
of offerings related to the medical industry.
Besides lots of ETFs devoted to the health sector
as a whole, there’s the HealthShares Infectious
Disease Fund, HHG; at first I thought that with
this fund you might need latex gloves to read the
prospectus, then I realized that this fund invests
in companies that fight infectious diseases not
sell them. Health Shares also has specialized
funds dedicated to chemotherapy research, HHK ,
gastrointestinal and what it calls "gender health"
companies (HHU - I suppose this fund’s province is
everything between the navel and the thighs), and,
of course, the fund whose companies are getting a
lot of business from me these days, the
HealthShares Orthopedic Repair ETF, ticker symbol
HHF.
With the fall in the US dollar, and a
US economy falling into recession much faster than
the rest of the world, you might be looking for
some international diversification, and the
numerous international index ETFs can do this far
cheaper than international mutual funds, and far
easier than converting US dollars into local
currencies to buy stocks in local markets.
Here, also, there are a huge number of ETF
selections, from the iShares/MSCI Japan Index,
EWJ, to ETFs that invest in all Asian stock
markets except Japan, such as the iShares/MSCI
Pacific ex-Japan, EPP.
Owning individual
Chinese stocks are fine if, should you live in the
Western Hemisphere, you don’t like to get a lot of
sleep at night.
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