by David Fessler, Advisory Panelist, Investment U
When Bad is Good
We’re nearly a month into the New Year, the United States has a new President, and many investors are looking forward with more than a little trepidation. They’re wondering if it’s at all possible to eke out a few gains in the coming months.
It’s a safe bet most investors didn’t do well last year. A quick look at how the major indexes have down in the last 13 months sums it up fairly well: the DOW is down 39%, the S&P fell 43%, and the Nasdaq slid nearly 44% since the beginning of 2008.
Recent market sentiment isn’t exactly painting a great picture looking forward, either. Markets slid negative in four out of the last five trading sessions. Adding to the sense of impending doom are record home foreclosures, soaring job losses, consumer confidence waning at a 15 year low, and bank failures on the rise. With all this bad news, how can the average investor make any money?
The answer to that depends on whether you believe this financial morass will end any time soon. Even with massive amounts of monetary stimulus, it will take some time to turn the global economic ship around. When that happens, there will be certainly be opportunities on the long end of the equation.
But in the short term, many companies will continue to report lower and lower earnings and guidance, and their share prices will continue to drift down as a result. After all, stock prices ultimately reflect the earnings power of a business.
With that trend in place, all one has to do is embrace the doom: bad is ultimately good. This line of thinking is what’s behind many ETF’s that bet on falling companies, and even entire sectors.
For instance, if you had invested in Deutsche Bank’s Banks Short Exchange Traded Fund (ETF) at the beginning of 2008, you’d be sitting on a tidy 184% profit. Trading primarily on European stock exchanges, the fund closed last September after Britain’s Financial Services Authority instituted a ban on short selling of financial stocks. It has since reopened to new investors.
Other financial short funds – available to investors here in the states — haven’t done bad either: Proshares UltraShort Financials (NYSE:SKF) is up over 4% since the beginning of this year and nearly 25% since the start of 2008. ProShares has no less that 46 short ETF’s covering just about every major sector as well U.S. Treasuries, and most of the world’s major currencies.
Rydex, the creator of the first short equity and fixed-income mutual funds, has a number of offerings as well. Its Inverse 2x S&P Select Sector Financial ETF (NYSE:RFN) seeks to provide a return that matches 200% of the inverse performance of the Financial Select Sector index. So far this year, it’s up almost 67%.
Juicy returns to be sure. But a word of caution: many of these ETF’s are small, thinly traded and can be very, very volatile. A market rally of 200-300 points – not that uncommon these days – can send them dropping like a rock.
But as part of a short-term trading strategy based on the performance – or lack thereof – in the financial or other targeted sectors, they may be worth a look.