1) VIX ETFs: The VIX index tracks volatility in the broad US stock market, and is popularly known as the “investor fear” gauge. Since Aug 1, as the european debt crisis and growth fears mounted, the CBOE VIX has risen roughly 80%. VIX-based ETFs like the ProShares VIX Mid-term provides returns correlated to the rise in the VIX index. This ETF has returned nearly 52% since Aug 1 as market volatility rose, and can provide valuable support to a pure stock portfolio in turbulent times. One thing to note: VIX-based products are actually based on VIX futures, i.e. on selling near-dated VIX futures to buy far-dated ones. As such, there can be situations where this “rolling” trade can lead to a loss (this is called Contango in the futures market) large enough to wipe out gains from volatility increases. At times like these VIX products can fail to act as hedges.
2) Inverse ETFs: Inverse ETFs aim to provide the same daily return as their benchmark index but in the opposite direction. For example, if the S&P500 falls by 1.5%, the ProShares Ultrashort S&P500 ETF (SDS) should rise twice the same amount, i.e. 3.0%. Note that this inverse matching of return occurs on a daily basis and over the long-term there may be drifts in how closely the ETF matches the (inverse of) the index’s performance. In the short term however, this can provide individual investors with a tool to short the market at a low cost. Before you plunge in, it is critical to determine the suitability of such inverse products for you. Inverse ETFs require higher than average knowledge of market trends and also need frequent monitoring. Again, these are not recommended as diversification strategies, but simply as a tool to limit portfolio volatility in the short term.
3) Put Spreads: Put options can be a relatively low-cost method to buy “insurance” against portfolio losses. A put spread involves buying a put option (or a right to sell) on a stock and then writing (or selling) a put option on the same stock but at a lower price. For example, if you believe that the S&P500 is going to plunge to a level between 850 and 900, and you want to protect your portfolio, one way to do so would be to place a put spread on the iShares S&P500 ETF (IVV). You can buy a put option at 900 and write a put option at 850 to offset some of the cost of buying the put option. If the S&P500 does go below 900, the put option you own comes “into the money” and you earn some profit to offset your stock portfolio losses, If the 900 level is never reached, both the put options expire worthless and all you lose is the cost of buying protection, i.e. price of put option purchased offset by the price of the put you sold. In this way, some of the loss of being invested in a falling market can be offset. Again, taking the advice of an investment professional is STRONGLY recommended before you plunge into setting up options strategies.

So what could go wrong if you invested in stocks based on these attractive measures?

Firstly, there is a fear in the market that earnings projected by analysts for the coming year may be too high. Consumers are obviously pessimistic about the economy – the University of Michigan consumer confidence index is down 9% since July, and unemployment remains above a stubborn 9% threshold. Are sell side analysts, notoriously slow with issuing HOLD or SELL ratings, pessimistic enough to match the black mood? Perhaps not – they have reduced earnings estimates for the S&P500 as a whole by about 0.55% over the last 4 weeks, according to Bloomberg, whereas the average reduction in earnings estimates for companies in the S&P500 is 1.33% during the same period. This may not quite do justice to the possibility of a double-dip recession. During the last recession (officially from December 2007 to June 2009), the peak to trough decline in S&P500 trailing twelve months earnings was approximately 37%. So if a serious slowdown comes to pass, you are likely to see analysts scrambling to reduce their target price for stocks. The dividend yield of 2.2% on the S&P500 is cited as another reason to pick up yield, but dividend payouts are also likely to come under pressure in a recession scenario.

So what’s an investor to do? Same as we always advise: look for stocks of companies with strong balance sheets and competitive advantages in their industry, and then diversify risk by broadbasing your investments across industries and countries. Well-run companies that meet the demands of a global customer base are a safe harbor in the current environment. We will touch upon some of these companies in our next post.

As always, discuss all investment decisions with your financial advisor, and be sure to consider the impact of an investment on your entire portfolio.

1) It’s the growth stupid. It all started with the ISM manufacturing survey and personal income and spending reports that came in below expectations on Aug 1 and 2. This started jitters about growth that are now powering the volatility in the market. While the Euro zone and US debt crisis remain problematic, it is not enough to explain the volatility in global equity markets. The debt downgrade served as the black (or maybe gray) swan event that triggered selling, but the real concern remains slowing growth in the US (because of continued unemployment and housing market quagmire), europe (debt crisis and austerity) and Asia (inflation fighting central banks and export slowdown). The data coming out in the US in the next few days (retail sales, consumer confidence, existing home sales etc.) will serve to provide direction to the markets if it comes out in sync with each other.

2) Bargain hunting: The whipsaw up-down moves of the last two days indicate that bargain hunters are out there in the markets looking for high-quality stocks to pick up at firesale prices. The question is if it is too early to bargain hunt as markets swoon every other day. The important thing is to identify high-quality stocks with solid balance sheets, emerging markets growth exposure, and competent management. Price to trailing 12M EPS for the S&P500 is almost where it was in March 2009, which would be a valuation buy signal if one believed in the earning capability of US companies. Given that companies have not exactly enjoyed a booming economy in the last few quarters and have still performed excellently on the earnings front, we retain faith in their ability to continue to grow earnings.

3) Timing is everything: If you are close to retirement (10-15 years away), then the turmoil is a reminder to seek more allocation in fixed income or income-generating assets like rental real estate, annuities etc. If, on the other hand, you are far from retirement the next couple months are a time to keep your eyes open for packing quality stocks into your portfolio. Also,on a market level, this is being hailed as the start of a cyclical bear market and a situation like this is not easily remedied in a few days or weeks. So stay tuned to the markets and make the most of the opportunity behind the turmoil.

PPO makes highly specialized polymer-based membranes used in chemical and magnetic separation and filtration processes. With existing successful business lines in conventional automotive lead-acid batteries, the company’s patented “separation” technologies and membranes also serve electrical, industrial, and medical device products. Strong earnings growth and intellectual assets make this stock a BUY from our perspective.

All investment decisions must be discussed with your financial advisor and must be viewed in the context of your entire financial situation.

So what’s driving this new yellow metal fever? Two things are in alignment:

Some people are scared
According to Josef Stadler of UBS Wealth Management, the ultra high net worth investors of the world are scared of where the global economy is headed and are stocking up on physical gold as the only reliable store of value. The anemic growth and debt load of developed countries, and a possible trade war between the emerging economies are likely to devalue currencies around the world, which leads investors to hide to the safety of commodities. Since most industrial commodities are also affected by poor growth, precious metals like gold emerge as the only safe haven for such investors.

And, given the ubiquity of gold coin sellers on TV and the internet, it is not just the super-rich that are scared. Retirees and middle-class savers are going for gold, as are the pension funds and mutual funds that manage their money.

The rest are reflexive
Even people who understand that gold, unlike crude oil or copper, has limited real demand in its physical form, are attracted by the metal’s ascent. It’s the old behavioral finance saw where a situation evolves to meet the perception of the market, as long as the perception is strong enough. In the post 2008 crisis world, investor psychologies have shifted and now assign a higher probability to ‘black swan’ events such as US treasury defaults. Even if a hedge fund manager does not believe in the value of gold, he/she observes that others do and is loathe to give up on the rally. In other words: a bubble is brewing.

Rising Incomes of Chinese Workers
Recently the City Government of Beijing announced that it would raise the city’s minimum monthly wage by 20 percent, to 960 RMB, or about $140. Many other cities are expected to follow suit. The typical Chinese worker still earns just $200/weekly, but rising food and housing prices, as well growing labor unrest is nudging wages upwards. Increased wages means increased demand for discretionary spending such as cars, cosmetics and household goods. Increasing wages also pulls more people into the labor force, some of them traditional caregivers such as housewives. Together these two trends are likely to lead to increased demand for consumer goods as well as retail food chains. Companies positioned to benefit from this change are MCD, YUM, GM and PG.

On the other hand, the increase in wages will make the “Made in China” label costlier. While some manufacturing units will move to other developing countries such as Vietnam and Bangladesh, many high tech products will continue to be produced in China at higher cost in the short term, which will then be passed on to the consumer. U.S. hardware companies like AAPL, HP, INTC, Lenovo (LNVGF) and AMAT have huge manufacturing operations and supplier relationships in China, which will impact their profit margins.

Rising Corporate Cash Piles
Due to growing economic uncertainty and soaring deficits, Corporate America (and Europe) are hoarding cash like there’s no tomorrow. Non-financial companies in the Standard & Poor’s 500 have a record $837 billion in cash, according to S&P. US corporate income in excess of expenses is at 0.8% of GDP. By squirreling away cash instead of investing in machines and new employees, companies may be counteracting the government’s fiscal stimulus, boosting unemployment and stifling chances of a robust economic recovery for developed nations. Unless businesses feel reassured about the federal deficits in the US and Europe, as well as confident about consumer demand in they will see little incentive to spend their hoard, hampering the very economic growth they are looking for.

Deflation and Inflation
The specter of deflation is looming over the US and Europe, even as protests against rising food and energy prices grip cities in India and China. Deflation puts a tight ceiling on companies’ ability to increase revenues, thus paying off debt and increasing their profitability. With a fall in the cost of production, companies that are overly dependent upon a cost advantage will find themselves squeezed as their competitors with superior quality will lower prices. For example, TGT may have an advantage over WMT in such a scenario, AAPL over DELL, PFE and JNJ over generic drug manufacturers.

On the other hand, inflation in emerging markets is likely to lead to political uncertainty as governments are rattled by public outcry. The growth in consumer demand that US companies have incorporated in their forecasts for China and India may not materialize in the coming quarters. The valuation of foreign stocks and ADRs will fall as inflation hits export-oriented growth.

For more investing ideas and practical guidance, visit www.themoneyladder.com.

The major criticism of the stress test is that there was no special test to measure the likelihood of a default by the Greek or Spanish governments. Another criticism relates to the low amount of recapitalization deemed suitable to bring the banking system back to health, a paltry $4.5 Billion.

On the bullish side, investors appear to be reassured by the level of government debt exposure of European banks, which had been a major cause of concern about them. The growth of euro zone banks in the booming markets of Asia is also noted as an offsetting positive to the glum domestic markets. The tests found that in the case of a “double-dip” recession and government debt market turmoil, Tier 1 capital ratio, used as a common measure of banks’ resilience to shocks, would decrease 10.3% in 2009 to 9.2% by the end of 2011. While this makes euro banks look pretty resilient, what is worrying is that the proportion of government support to banks remains relatively high.
Perhaps the most positive impact of the test results is the transparency it has brought to how the regulatory agencies measure the banks’ health, a view that guides policy decisions and ultimately affects the course of the stock and bond markets.

The Euro Stoxx Bank index is up 0.42%, while the Euro is at a 7-week high versus the yen on Monday morning.

Get the stress test results here: http://www.c-ebs.org/EuWideStressTesting.aspx