“A pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty.” – Winston Churchill
The strong undercurrent of volatility is noticeably palpable, with a perfect storm forming out of the recent events that have combined the unbridled forces of nature with a high degree of geo-political instability.
While the equity markets hardly emerged intact from a brutal week, they did manage to recover some losses by week’s end. The Dow Jones Industrial Average (DJIA) landed at 11,858 on Friday, down almost 200 points on the week. It had plunged below its 50-day moving average on Tuesday and, in spite of a strong bounce-back towards the week’s end, remained below that level. The Bull-Bear Battlefield will likely be played out between the previous support level of 11,500 and the next likely resistance point of Dow 12,000, about where the current 50-day MA ended last week.
If your reference point is more the S&P 500 Index (SPX), then what you will notice is that it ended Friday at 1,279, down slightly more than 20 points. Until last week, 1,300 looked like a promising level of support, yet it too was pierced in response to Japan’s horrific saga. Now, 1,300 could easily become the bar of resistance, and 1,250 may become the next test to the downside.
The Bulls ended the week with a heads-down, damn-the-reality approach, in spite of a ridiculously high level of world drama and turmoil.
Solid economic recovery sentiment? Or foolish “What, me worry?” attitude?
It’s always a question of perception, of course, and sentiment doesn’t always make sense. Looking at some of the events that have unfolded last week, however, it might give pause to what the Bulls seem to be seeing.
Consider Japan. There was, sadly, the train wreck of carnage experienced by the great island-country. The awful trifecta of earthquake, tsunami and nuclear-meltdown danger rocked the markets; yet investors seemed surprisingly easy to sooth by the always sonorous melody of QE3 sung by the bandleader of the Federal Reserve Bank.
Consider Libya. Yes, there shall be war, and yes, investors focus on the economics of it. Will a regime change occur? Who will control the flow of oil when and if that happens? What happens to that same flow in the meantime? Anyone who says they have a clear answer on this one might, at best, have a 50-50 chance of being right.
Consider Saudi Arabia. Sure, there was a sudden burst of violent suppression of protesters by the Bahrain government last week, which wasn’t given much lead time by the mainstream media, but the real story remains its larger neighbor across the waterway, Saudi Arabia. Any serious exhibition of unrest in the Middle East’s leading oil producing country would make Libya seem like a footnote in the resulting story of the “gastronomically” high oil prices that would result from chaos in the land of Saud.
Consider Portugal. A European country facing potential debt default? Almost seems quaint, somehow, compared to the commotion unfurling in other world hot spots. True, in an ordinary news cycle, the fact that Portugal’s debt rating has been downgraded several notches by Moody’s would undoubtedly smack down the markets substantially. Now? Not so much. However, it would be foolish to dismiss the possible consequences of outright default by the P in the PIIGS, regardless of what else might be unfolding in the rest of the macro-economic universe.
Volatility, in other words, is being thickly painted upon the world economic canvas right now. One intelligent response to the fear in the markets is to apply a pro-active coat of Hedge, as in hedging. There are a number of ETFs and ETNs that can be used to accomplish that purpose. How you use them and to what extent depend on your overall trading or investment approach. However, it is useful to remember that hedging is effectively the same as buying insurance, which everyone of course hates to pay. That is, until you get hit by a car. Or by a Black Swan flying into your windshield.
Here are three ETNs that are worth considering as hedging tools for your portfolio. They are all based upon the VIX, the Chicago Board Options Exchange Volatility Index, which measures expected volatility in markets using options on the S&P 500 Index. The VIX rises as traders seek out protection from down-bound markets.
First, there’s VXX (iPath S&P 500 VIX Short-Term Futures ETN), which tracks the VIX. It offers exposure to VIX futures contracts and reflects the implied volatility of the S&P 500 Index.
Next, there’s VXZ (iPath S&P 500 VIX Mid-Term Futures ETN). This tracks the S&P 500 Mid-Term Futures Index, which offers exposure to slightly longer term VIX futures contracts then the VXX.
Finally, if you want to really leverage your hedge, take a look at TVIX (Daily 2x VIX Short-Term ETN). It tracks the S&P 500 VIX Short-Term Futures Index. A leveraged ETN, TVIX provides 200% vs. a regular, non-leveraged ETN. So use wisely, since it will not only potentially double your profits if the trade goes your way, it will also double your losses if it gets away from you.