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ETF Periscope: Benny and the Greeks

Posted on the 26 September 2011 by Phil's Stock World @philstockworld

ETF Periscope: Benny and the Greeks

“Why don’t they make the whole plane out of that black box stuff.“  –Steven Wright

ETF Periscope: Benny and the Greeks
Ben Bernanke struck out swinging.

Next up: the European Union’s heavy hitters. How they handle the curve ball will go a long way toward establishing the market’s direction for the upcoming week and, most likely, for the remainder of the year.

On Wednesday, the Federal Reserve Chairman announced that the Fed was effectively lowering long-term consumer borrowing costs. The vehicle for that action was dubbed “Operation Twist,” a $400 billion swap of longer-term Treasuries for similar short-term holdings.

Wall Street, which apparently wanted to see a more dynamic level of economic stimulus, was so disappointed that it staged an epic sell-off of equities, one that dropped the Dow Jones Industrial Average (DJIA) by a stunning 600 points over a two-session period and about 700 points on the week.

The only really good news for the market was that on Friday, the Dow was up 37 points.

On the face of it, that hardly compensated for the 6.4% weekly decline, its worst since October of ’08. However, the fact that the market found support for the second day in a row at the same level may prove to be significant. It likely meant that acceptable price points for stocks were finally identified by institutional investors, and it kept the market from plunging below the lows of the year.

Coupled with the fact that Wall Street was heading into a weekend already laced with uncertainty due to upcoming EU debt crisis deliberations, a Friday failure into the close could have really sent investors scurrying for the exits “en masse.”

Obviously, the Blue Chip index wasn’t the only victim of the week. In addition to the Dow being down over 6%, the S&P 500 Index (SPX) was slammed lower by 6.6%, and the Nasdaq (COMP) fell 5.3%.

Also noteworthy, recent commodity darlings gold and silver got seriously hammered on Friday, with gold losing over 5% and silver diving down around15%.

Now that Bernanke has cleared his throat and moved off center stage, the players comprising the EU crisis are again returning to the spotlight.

In spite of systemic monetary problems within a number of EU member nations, primarily the PIIGS (Portugal, Ireland, Italy, Greece and Spain), it appears that investors are capable of being placated by promises of solutions in lieu of the real thing. This was evidenced less than two weeks back when France’s Nicolas Sarkozy and Germany’s Angela Merkel announced, in tandem, their solidarity in maintaining the EU and the single currency.

However, voices of a less optimistic tenor emerged last week, contributing to the market’s dive. These included the International Monetary Fund’s (IMF) Managing Director, who declared dark clouds are over Europe, and the Greek Finance Minister, who told fellow lawmakers that the current agreement could collapse into a disorderly default. Amplifying the whole default scenario was a member of the European Central Bank’s Governing Council, who said a default by Greece could no longer be ruled out.

During the course of the weekend, however, the opposing team once more marshaled its forces to present a happy face. The IMF held its annual meeting over the weekend and announced that its members “agreed to act decisively to tackle the dangers confronting the global economy,” in addition to doing “whatever it takes.”

Encouraging words, true. Yet it was a communiqué that, while generous with ideas, was not so strong on solutions. However, since it is after all the IMF, one can assume that the “whatever it takes” part refers to throwing gobs of money at the problem, even though previous action of a similar nature merely postponed the systemic problems rather than corrected them.

One of the better known attendees of the gathering, billionaire investor George Soros, wasn’t quite on the same page, saying EU’s sovereign debt crisis is worse than the problems leading to the crash of ’08.

Maybe he is just on the short side of things and is giving the situation a sleight nudge. Or maybe he is an objective observer who recognizes a bad crisis when he sees it.

Also attending was U.S. Treasury Secretary Tim Geithner. His words of wisdom to the other IMF leaders included the suggestion of having the European Financial Stability Facility, a company owned by Euro Area Member States, use more leverage to bolster its guarantees.

More leverage. Interesting concept. Didn’t that contribute slightly to the last crash just a few years back?

In any event, how investors choose to hear things this week will become established early on. If the IMF remarks are viewed with skepticism, then the year’s lows will be retested. If they offer sufficient encouragement, investors might view the current market as oversold and decide to get back in.

Either way, whatever market momentum occurs early in the week will be tested on Thursday, when both Gross Domestic Product (GDP) and weekly job numbers are reported. No matter what the latest data on the U.S. economy indicates, it will likely cause us to re-analyze Big Ben’s latest course of action through its prism.

What the Periscope Sees

This past week, the VIX was up over 30%, revealing once again how potent a hedge it can be. If you held one of several ETFs that track the VIX, such as VXX (iPath S&P 500 VIX Short-Term Futures ETN), it would have been exactly the type of insurance that, at least in hindsight, you would be happy to have purchased. The question now is this: With current levels in the low 40’s, which is on the high side historically speaking, is it cost effective enough to warrant buying now?

Maybe, maybe not. During the darkest days of the ’08 crash, the VIX spent six months over its current level. Another week like the previous one could send it into the 50’s. With sentiment leaning heavily toward the fearful side of the scale, it remains a hedge worth considering, especially if your portfolio is lacking in that arena.

It is worth noting that when the VIX goes up, it indicates uncertainty, usually accompanied by a drop in the equity markets. Inversely, when the VIX goes down, the Dow tends to trend up.

ETF Periscope

Full disclosure:  The author does not personally hold any of the ETFs mentioned in this week’s “What the Periscope Sees.”

Disclaimer: This newsletter is published solely for informational purposes and is not to be construed as advice or a recommendation to specific individuals. Individuals should take into account their personal financial circumstances in acting on any rankings or stock selections provided by Sabrient. Sabrient makes no representations that the techniques used in its rankings or selections will result in or guarantee profits in trading. Trading involves risk, including possible loss of principal and other losses, and past performance is no indication of future results.

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