Striking a Tragic Fate – Are Equity ETFs Destined for a Downfall?

[Chart courtesy of MarketWatch.com]

As the situation in Europe unfolds, equity ETFs tumbled once again as the S&P fell 2.79%. And after a period where it looked like volatility was falling, the risk switch has turned back on again, with the VIX rising 16.05% to 34.77.

Also, the dollar improved against the Euro to end the day at $1.37/Euro. We might’ve been approaching bull range, but uninspiring economic indicators and political frictions in Europe suggest we won’t be making much headway any time soon.

Just when the European crisis appeared to be improving, the emergence of the Greek referendum has put a nail in the coffin. Letting the public decide whether or not to accept the bailout can have a destabilizing impact, if it’s rejected. The bottom line is that Greece completely lacks credibility and is becoming the laughing stock of the EU. But the joke isn’t funny anymore.

Greece’s interests are misaligned with the rest of the Eurozone, and its history of financial mismanagement starting from the top continues. It’s clear that Greece’s lack of fiscal discipline and financial irresponsibility is the anchor that will bring down the EU ship, if it can’t get its house in order. The Greeks can’t have their cake and eat it too by rejecting austerity but wanting to keep the Euro. In other words, the probability of default has edged up significantly.

A testament to this heightened Eurozone tension, European bond yields notably spiked. An already embattled Italy had its 10-year bonds hit 6.33%, over 450 bps higher than comparable German bonds. The ECB had to intervene to help keep Italian yields down while also employing similar measures in Spain. These astronomical borrowing costs are just adding more fuel to the raging fire that is the debt crisis.

Meanwhile, the potential for widespread contagion has prompted the IMF to potentially offer six-month credit lines for countries facing financial difficulty. Clearly, the IMF is bracing for a possible full stage Greek collapse that could have a violent ripple effect throughout global markets.

While recent trends have supported my decision to gain some equity exposure, this week’s sudden turn of events supports my sell stop philosophy, which is of paramount importance to protect your portfolio in a severe downside scenario.

A majority bond ETF and cash position may not have seemed fruitful last month, but days like today serve as a reminder that conservatism reaps rewards during volatile periods.

About Ulli Niemann

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