Sunday Musings: Still Not Getting It

Recently, the WSJ (subscription required) featured a piece with the title “Unstable Condition.” Let’s look at a few highlights:

Q: Are there ways an investor can protect against a rise in the market’s volatility—or even profit from it?

A: Investors have endured a bumpy few years. The market tumbled in 2008, then rose sharply in the subsequent two years, leaving some investors with virtual whiplash.

Now, with markets uncertain and growing fears of a new economic slowdown, some investors are searching for ways to protect their portfolios from a new bout of volatility. And some are even looking for ways to profit from renewed turmoil.

The traditional advice for those seeking shelter is to create a diversified portfolio featuring companies in stable businesses such as tobacco, utilities and consumer staples, or to shift into bonds and dividend-paying stocks. But the market downturn in 2008 hurt all kinds of companies and corporate bonds, including those that seemed safe. Indeed, there’s evidence that markets around the world are more in sync than ever, making it harder to escape downturns.

Some advisers now recommend investments like the iPATH S&P 500 VIX Short-Term Futures ETN, an exchange-traded note designed to gain in value during sharp moves in the broad stock market by tracking the CBOE Market Volatility Index. These particular notes have a longer track record and more trading volume than similar vehicles. Some advisers prefer exchange-traded funds—like ProShares VIX Short-Term Futures and ProShares VIX Mid-Term Futures—to ETNs for volatility protection, partly because the funds often trade more than the notes, making them easier to move in and out of.

None of these three vehicles have done well this year amid relatively placid markets. The iPATH notes are down more than 30%, while the short-term ProShares ETFs are off about 30% and the mid-term ETFs have lost about 16%. Recent market instability has helped the investments, however.

Another idea: index-put options, or options that pay off if an index, such as the Standard & Poor’s 500, tumbles abruptly. VIX options pay off if the Volatility Index surges. But options aren’t ideal for many individual investors because they can move quickly, causing abrupt and extensive losses. Some new volatility products are designed for pros, not individual investors, because they can move 5% in a day. One example: VelocityShares Daily 2x VIX Short Term ETN.

[Emphasis added]

It’s obvious from the above that nothing has been learned from past market disasters, which makes this story pretty much useless, unless you want to engage in the suggested investments, which are of dubious value at best.

The article goes on for a few more paragraphs desperately trying to find some magical investment tool that you can purchase in order to ride out whatever the market throws at you.

I have a better idea. As I elaborated in yesterday’s post, go to all cash and remain on the sidelines via my trend tracking methodology, so you don’t have to deal with wild ideas like the ones above attempting to keep you invested at all costs.

Nowhere on Wall Street, and especially not from their well trained army of salesmen, will you ever hear that being on the sidelines could be advantageous to your financial health.

There are very few advisors, who recognize the wisdom that cash can be an appropriate place for your portfolio to be when the market heat is on and global uncertainties reach new highs.

We seem to be inching closer to greater exposure to a variety of these uncertainties, any of which can pull the rug out from under the bullish crowd and turn this debt circus into a bear market fest.

Be prepared by keeping your focus on your exit strategy, so that you can minimize portfolio damage, should the downside come into play in a big way.

About Ulli Niemann

Ulli Niemann is the publisher of "The ETF Bully" and is a Registered Investment Advisor. Learn more
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