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ETF Periscope: Bulls Gain Steam, but Euro-Zone Concerns Bear Close Watch

Posted on the 24 January 2012 by Phil's Stock World @philstockworld

Courtesy of Daniel Sckolnik, ETF Periscope

“Confusion is a word we have invented for an order which is not understood.” –  Henry Miller

ETF Periscope: Bulls Gain Steam, but Euro-Zone Concerns Bear Close Watch
The Dow Jones Industrial Average (DJIA) rose by almost a full percentage point on Friday, but like so many aspects of the current market, that number is somewhat misleading.

Tech leader IBM powered the Dow to its fourth winning day in a row, which left the blue-chip index up 2.4% on the week. However, with IBM being the highest-priced component within the Dow universe, its upward move, coming in at over 4%, disproportionally raised the Dow’s bottom line.

For comparison, if you take a look at the S&P 500 Index (SPX), it gained a relatively paltry 0.1% on Friday. However, the benchmark index, which offers a far more accurate read on the equity market in general, did manage to gain 2% on the week, placing it at a level not seen since late July of 2011. It now has a very minimal cushion of 1% atop the psychologically important 1,300 level, while also sitting relatively high above its own 200-day moving average.

Rounding out the big three indexes, the Nasdaq Composite Index (COMP) lost 0.1% on Friday, suffering defeat at the hands of the bad beat investors put on Google (GOOG) following its unenthusiastically received 4Q earnings report.

Fourth quarter earnings season has, on the whole, been the prime mover for the mini Bull Run that Wall Street has experienced since the ball dropped on the New Year. Though the numbers reported by companies so far have generally met analysts’ expectations, the upward trend in stocks year-to-date can be at least partially attributed to the fact that, so far for the year, domestic reports out of Washington have fallen into the “neutral-to-fair” category.

Probably a far greater factor in January’s current upward trend has been the fact that negative noise out of the euro-zone has been minimal. And, while investors are hardly dancing in the streets due to enacted solutions geared towards solving the EU debt crisis, sentiment does seems to be leaning towards the possibility that the worst of the matter may be baked into current stock prices.

This assumption may prove to be a major flaw, at least in the long term.

While the new head of the European Central Bank (ECB), Mario Drahi, has so far managed to convey the right sentiments at the right time, helping to effectively offset some of the rumors and innuendo that have at times injected high doses of volatility into the market, the euro-zone remains a powder keg simply due to the massive debt owed by the PIIGS (Portugal, Ireland, Italy, Spain and Greece). There is only so much that Germany, France, and even the International Monetary Fund can do to stem the bleeding without inflicting wounds on themselves.

The fact remains that the weapon of choice expounded by both investors and the broader European Union, deeper austerity measures, is nothing if not a prescription for recession for EU member-states. And, with an estimated 18% of profits of S&P 500 companies coming from Europe, it is not a stretch to see that a slump in EU growth will impact both U.S. and global investors in a major way.

In the meantime, enjoy the Bull, but don’t be shy about humoring the Bear and offsetting your portfolio with a few smart hedges.

What the Periscope Sees


Speaking of hedges, one of the Periscope’s favorites remains the VIX (Chicago Board Options Exchange Market Volatility Index), which serves as a reasonably good read on investor sentiment in general, and an excellent tonic to a reactionary market specifically.

On Friday, the VIX ended the day at 18.28, a number that it hasn’t seen in six months. Prior to last summer’s “euro-swoon,” the VIX had established a solid support level around 15. On the other hand, once the cracks in the EU began to come into sharper focus, the VIX zoomed up close to 50. With some of the euro-zone issues being addressed but not solved, there is a good risk-to-reward trade to be made here.

While you can’t trade the VIX directly, you can use one of several liquid ETFs that track the Volatility Index. The most popular and most liquid choices continue to be the VXX (iPath S&P 500 VIX Short-Term Futures ETN), which tracks the near-term futures, or the VXZ (iPath S&P 500 VIX Mid-Term Futures ETN), which tracks VIX mid-term futures.

ETF Periscope

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

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