Personally, I don t expect> much financial drama over the next year. Stocks seem only a touch expensive relative to earnings. Earnings seem normal as a share of the economy. Powerful deflationary and inflationary forces (lax consumer demand and looming money creation, respectively) are offsetting each other, and should do so until world economic growth heats up, perhaps a year from now. And the dollar seems wobbly, but no more so than currencies that compete as a store of the world s winnings.
I could easily be wrong about any or all of these things, though. Stock prices and earnings spent several years too high, and so might now plunge to depths that are too low by the same degree. Emerging economies might grow fast enough to spur energy, food and metal inflation, even if rich countries stagnate. America might create so much money that the dollar plunges in value. For investors who fear the worst, and who wish to make protective or pessimistic investments, here s a round-up of ones that don t require options or futures trading, physical asset storage or the opening of foreign accounts. All are exchange-traded funds, or ETFs, which can be bought and sold like stocks in ordinary brokerage accounts.
Make Money If Stocks Plunge
The market is more likely to rise than fall on any given day. The longer you hold a broad basket of stocks, the better your chances of profiting. With inverse or bear funds, just the opposite is true. They re meant as short-term bets on a decline in stock prices, and are unlikely to pay off as long-term holdings. That means investors needn t agonize over slight differences in management expenses; an extra two-tenths of a percentage point per year compounds considerably over 20 years, but doesn t mean much over one summer.
Start by choosing an index. Broad-market ones like the S&P 500 or Russell 2000 are fine for generally pessimistic strategies. There are also style indexes, if you think, say, stocks with high price/earnings ratios (growth stocks) will get hit harder than ones with low P/Es in the market s next leg down. (That s just what happens during most market downturns, but it hasn t happened so far during this one Most of these funds are available with or without leverage. Levered bear funds try to produce double or triple the underlying indexes movements, but in the opposite direction.
Three warnings on leverage: First, needless to say, it multiplies risk. On Tuesday market averages jumped 2.4% to 3.5%, merely on news that consumers in a survey guessed conditions would improve in coming months. A skeptic might say that consumers are only more chipper because stocks have risen in recent weeks, and that their mood shouldn t thus be used to predict yet more stock movements, but the point is, it doesn t take too many perplexingly bullish days to hurt a levered bear investor. Second, levered funds are usually tuned to daily index performance, not yearly performance. Depending on market volatility, those amplified daily returns might compound to well higher or well lower than the indexes return over weeks, months or years. Third, bear funds in general aren t great for minimizing taxes, since they re for short-term bets, but levered bear funds especially spew out heaps of taxable gains during good years, because the derivative contracts that power them don t enjoy the same tax benefits as stocks.
Have a look at some bets against stocks on this table, and then move on to inflation.
|SH||S&P 500||Large company||no|
|SDS||S&P 500||Large company||2X|
|BGZ||Russell 1000||Large company||3X|
|RWM||Russell 2000||Small company||no|
|TWM||Russell 2000||Small company||2X|
|TZA||Russell 2000||Small company||3X|
|SJF||Russell 1000 Value||Value||2X|
|SFK||Russell 1000 growth||Growth||2X|
Profit From Soaring Consumer Prices
Gold is too often touted as the best protection against inflation. I ve argued before that its price is mostly linked to doomsayer speculation, not actual industrial demand, making gold a poor choice for the job. If prices soar, the world might believe more in gold, but it won t need more gold. Better to buy diversified metals ETFs like the ones listed below, along with ETFs that track energy and food prices. (Again, I list these as options for betting on raging inflation, not as recommendations. I think we re ultimately headed for heightened, but not runaway inflation, and that the best hedge is stocks, especially cheap ones attached to dividend-paying companies that sell needed goods.) If you re not sure which basket of commodities will see the most inflation (and you re not), opt for a broad commodity ETF that holds all of them.
|DBB||Aluminum, zinc, copper|
|DBA||Corn, wheat, soy beans, sugar|
|DBE||Light sweet crude, heating oil, Brent crude, gasoline, natural gas|
|GSG||Agriculture (approx. 24%), metals (11%), energy (65%)|
|RJI||Agriculture (approx. 35%), metals (21%), energy (44%)|
|DJP||Agriculture (approx. 36%), metals (30%), energy, (34%)|
Cash In on a Dollar Crash
For the dollar s value to drop, it must do so relative to something. A decline relative to the price of goods is simply a restatement of inflation, covered above. But the dollar can lose value relative to other currencies, too. To protect against that, use ETFs to either bet against the dollar or for some other currency. Note that dollar bear ETFs necessarily bet on other currencies, usually a basket of them. You can accomplish the same thing by buying funds that bet on the currencies of rich nations, emerging economies, geographic regions and so on. Finally, you can buy a fund that purchases currencies associated with high interest rates while shorting ones with low interest rates. Such carry trade funds net holders attractive interest rates, and rise in value if the high interest rates force currency-boosting frugality while the low ones allow currency-damaging profligacy.
|* These currencies are officially tied to the dollar, making the note a bet these countries will revalue their currencies, allow them to float freely or link them to other currencies.|
** This fund buys the three highest-yielding and shorts the three lowest-yielding among Group of 10 currencies (U.S. dollars, euros, Japanese yen, Canadian dollars, Swiss francs, British pounds, Australian dollars, New Zealand dollars, Norwegian krone and Swedish krona).
|UDN||Dollar bear (against euro, Japanese yen, British pound, Canadian dollar, Swedish krona and Swiss franc)|
|FXE, ERE, ERO||Euro|
|ULE, URR||Euro 2X|
|FXB, EGB, GBB||Pound|
|FXC, CUD||Canadian dollar|
|BNZ||New Zealand dollar|
|CYB, CNY||Chinese yuan|
|SZR||South African rand|
|PGD *||HK dollar, Singapore dollar, Saudi Arabia riyal, United Emirates dirham, Chinese yuan|
|DBV **||Carry trade (G10)|
Bet On Other Assorted Mayhem
Consumers becoming even less able to afford niceties: ProShares UntraShort Consumer Goods (SZK)