Making Money Alert
Beware of the Hope Rally
04/08/2009
This week started out with a pause in the recent market rally. However, today the play button on the rally seems to have been pushed once again. I think Monday's pullback makes sense, especially in the context of the big run we've seen in stocks during the past four weeks. I also think that we could see a continuation of this bear-market rally, possibly all the way up to the 200-day moving average.
From a historical perspective, a run-up to the long-term moving average makes perfect sense. In the chart below of the S&P 500 during the bear market of 2000-2002, there were several occasions when stocks rallied off of their lows either to just below, or just above, the 200-day moving average.
I consider these sharp bear-market moves to be what I call "hope rallies." What this means is that investors are hoping the worst is behind us, and they are hoping that stock prices will be higher several months down the road.
If we take a look at the chart below of the S&P 500 during the past 12 months, we instantly see just how far this market has to go to return to pre-bear market levels. Of course, you also can see the strong recent surge in equities.
Despite the recent strength in stocks -- and the possibility of a continued hope rally -- I think the market is still confronting a host of nasty negatives. In fact, I think the U.S. economy still has a long way to go before it rights the ship of rampant debt creation, surging unemployment and contracting consumer spending. Then there is the real estate market, which continues its rapid deleveraging -- both on the housing front, and the commercial front.
And speaking of that rampant debt creation, let's review just how much new debt is being taken on by the federal government, a.k.a., you, me, our children, our children's children, and so on.
Under President Obama's budget, the non-partisan Congressional Budget Office (CBO) projects that the national debt will soar during the next 10 years from 40% of GDP today to an incredible 82.4%. By comparison, when President Reagan left office, the national debt was 42% -- a number that I think is way too high, yet is still only half of what the CBO projection is a decade from now.
The president's budget also states that total federal borrowing will grow by $2.7 trillion this year alone, an increase of 27% in one year. It's almost unfathomable to think that the budget President Obama has proposed for this year increases federal spending by a whopping 34% during the previous year, with a total of $4 trillion (with a "T") in federal spending.
I fear that this massive debt crater our leaders are digging the country into will have significant consequences for the economy and the stock market in the years ahead. These consequences won't be positive for the bulls, and it's another reason why I advocate approaching this market with extreme caution.
I think it is very important for you to remember that our economy is still in the midst of the greatest storm since the 1930s. History shows us that troubling economic times don't follow a path straight down. As we've seen, strong bear markets are replete with so-called "fits and starts," occasions where stock prices re-test their lows before moving upward. This latest rally is one of those starts, but I suspect the market will be back to having fits sooner rather than later.
When those fits will start is anyone's guess, and that means if you are going to wade into these treacherous market waters, you must do so with a strict sell discipline -- and with a strong constitution that's ever intrepid in the face of loss.
A Few Cash Alternatives
I know a lot of Alert readers are committed to having a high cash position during this bear market. So, it's no surprise to me that lately I've received a lot of questions regarding cash alternatives. Many of you are understandably not content with the very low rate of return being paid by today's money market funds.
And while I feel that the money market is the safest, most liquid place to park your serious money during this time of market flux, I do think there are several safe alternatives to your run-of-the-mill money market fund.
One of my favorite money market alternatives is the iShares Barclays 1-3 Year Treasury Bond (SHY). This investment seeks results that correspond generally to the price and yield performance of the short-term sector of the U.S. Treasury market as defined by the Barclays Capital 1-3 Year U.S. Treasury index.
This short-term Treasury bond fund is a good place to park cash. In fact, we have a 25% allocation to this fund in our High Monthly Income. This fund has served us well during the past year, and I suspect it will continue doing so in the year ahead.
The current yield on SHY is 2.05%, so if you are looking for a good place to get a little more yield than your money market account, check out SHY.
In addition to SHY, there are two other cash alternatives that are worthy of checking out. They are the WisdomTree U.S. Current Income Fund (USY), a fund yielding 0.35%, and the PowerShares VRDO Tax-Free Weekly (PVI), which has a current yield of 1.64%. Both of these offer decent cash alternatives, although they pale in comparison to SHY in terms of yield.
So, if you are looking to take a little of your money and put it into cash alternatives, here are three solid candidates.
ETF Talk: Beating Bear Markets
Millions of people have seen their 401(k)s, IRAs and stock market portfolios hammered by the current bear market. As the S&P 500 and the Dow slid further and further last year, many investors flocked to so-called bear market funds. The general philosophy behind bear market funds is to take advantage of market slumps by investing in positions that go up when the market goes down.
Bear market funds use various strategies to profit, although the chosen method usually is through short positions. Certain exchange-traded funds (ETFs) now are beginning to use derivatives and options to replicate the inverse of market indexes instead of simply shorting them.
In 2008, several bear market funds -- shorting all kinds of stock exchanges -- performed well. They rose while the global markets sputtered. However, history shows that bear market funds have been long-term laggards. While bear market funds are not permanent fixtures in most portfolios, since the stock market tends to rise over time, they are a great way to seek short-term gains in a sagging market.
Depending on the ETF you choose, for every 1% dip in the market, you can turn a profit of 1%, or even 2% if you use a leveraged position. Now, let me introduce you to a handful of bear market funds.
The ProShares Short S&P 500 (SH), which shorts the S&P 500, was up 39.21% last year. More aggressive investors bought the twice-leveraged UltraShort S&P 500 ProShares (SDS), which returned 61.36% in 2008.
For investors interested in international bear market funds, ProShares Short MSCI EAFE (EFZ) shorts European, Australasian and Far Eastern markets. This ETF had a one-year return of 38.90%. Risk-taking investors may be interested in the twice-leveraged ProShares UltraShort MSCI EAFE (EFU), which had a 51.92% one-year return.
While bear market funds are a great way to profit during market slumps, beware of bear market rallies such as the one we've had recently. SH and EFZ both are down more than 20% since the rally started on March 9. As leveraged funds, SDS and EFU each dropped nearly 40% in the last month.
Long | Short |
S&P Dividend SPDR (SDY) | ProShares Short S&P 500 (SH) |
iShares MSCI Emerging Markets Index (EEM) | UltraShort S&P 500 ProShares (SDS) |
ProShares Short MSCI EAFE (EFZ) | |
ProShares UltraShort MSCI EAFE (EFU) |
The market's extreme volatility and uncertainty during the last month leaves an open question about how to play the rally. For those investors who think the rally will extend further into the year, a long position might be a good idea. Investors who think that the rally is going to fizzle may decide that a short position is best.
If you want my advice about which ETFs to trade and when, check out my ETF Trader service by clicking here. As always, I am happy to answer your questions about ETFs. To send me your questions, click here. I will try to follow up in a future ETF Talk.
CEOs: A Lack of Confidence
As I was writing today's Alert, I came across what I feel are some rather disturbing survey results from our nation's CEOs. According to the Business Roundtable's quarterly CEO Economic Outlook Index, two-thirds of U.S. chief executives plan additional layoffs and expect sales to decline in the next six months as their confidence in the economy continues to fall.
The CEO Economic Outlook Index fell to negative 5, which is the first negative reading in the survey's six-year history. To put this statistic in perspective, consider that a reading below 50 means CEOs expect economic contraction rather than growth. So a negative 5 is, well, very, very negative indeed.
The poll of 100 U.S. CEOs also found that many now expect real U.S. gross domestic product to decline 1.9% this year. That is well below their December forecast, which anticipated flat GDP for the year.
In what is perhaps the most disturbing, and potentially harmful development for the stock market going forward, 71% of the CEOs surveyed said they expect to cut their U.S. work forces over the next six months. Nearly two-thirds (66%) say they expect to reduce capital spending.
I think what makes this survey even more bearish is that it was conducted between March 16 and March 27, a time when the market was in full-blown rally mode. Now in my opinion, the bearish sentiment and downright lack of confidence by the decision makers of corporate America means there will likely be tough times ahead for the U.S. economy, and by extension, the U.S. equity market.
ETFs: Please Drink Responsibly
I've read a lot of bad press lately regarding ETFs, and in particular levered ETFs. There seems to be a backlash on the use of volatile, levered ETFs as a way to build long-term wealth.
Well, to this sentiment I say, duh!
Some ETFs, and in particular those that are levered two and three times, are not intended to be used as long-term wealth builders. These ETFs are trading vehicles, pure and simple. They should be used with a restricted time frame of anywhere from a few weeks to a few months tops.
These volatile, levered ETFs are not buy-and-hold investment vehicles, nor are they to be used for the average risk-averse investor seeking long-term gains. Rather, they only should be used by the highly risk tolerant, by those willing to employ strict stop losses and by those unafraid to take a loss if things go south.
So please, you people in the financial media, don't continue scaring investors into thinking that levered ETFs are inherently intoxicating. If you drink them responsibly, you'll reap the pleasures and avoid the hangover.
The Wisdom of Science
"Science, my lad, is made up of mistakes, but they are mistakes which it is useful to make, because they lead little by little to the truth."
-- Jules Verne
The great science-fiction writer was dead on with his assessment of how the scientific method arrives at truth. This lesson also can be applied to managing your money, as it is essential for us to learn from the mistakes we've made. If we're smart, those mistakes will lead us little by little to the truth.
Wisdom about money, investing and life can be found anywhere. If you have a good quote you'd like me to share with your fellow Alert readers, send it to me, along with any comments, questions and suggestions you have about my radio show, newsletters, seminars or anything else. Click here to Ask Doug.