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Five Ways To Profit From a Coming Market Collapse

How to make money in the coming collapse.

The recent sell-off in global financial markets has put the fear of God into many investors. Financial crises in Greece and elsewhere on Europe’s periphery, the Chinese government slamming the brakes on economic growth, and a neck-snapping sell-off in commodities in early May have left many investors bewildered and nursing their losses.

Managing money in an environment like this is not easy. Managing investors’ psychology is even harder.

As part of an effort to minimize the psychological impact of sharp drops in the market for clients at my firm Global Guru Capital, I’ve developed what I call my “hedge portfolio.”

Its objective is to assemble a set of assets — almost always in the form of specialist exchange-traded funds (ETFs) — that make money when financial markets fall out of bed.

Now I don’t run the “hedge portfolio” as a separate portfolio as such. But I do occasionally invest in some of these positions — including the ones below — for my discretionary clients. This helps minimize the drawdowns in the portfolios and helps my clients sleep well at night.

Investing in these positions can do the same for you.

1. Short MSCI Emerging Markets (EUM)

For all the talk about how emerging markets are set to dominate our economic future, this “red hot” asset class is almost always the first one to fall out of bed once markets revert back to “risk-on” mode.

That’s par for the course. Last year, the MSCI Emerging Markets Index endured two stomach-churning corrections, falling 13.96% in February, recovering to new highs, and then dropping another 16.26% in May. These two corrections shook out a lot of investors — most of whom later regretted panicking and selling out.

The best way to profit from these short-term moves is through the Short MSCI Emerging Markets (EUM). This ETF is the inverse of the MCSI Emerging Market Index. The fund is designed to profit when the index goes down.

This position is up 8.46% over the last month, and is now trading above its 50-day moving average.

 

Graph

2. Proshares UltraShort Euro (EUO)

With the financial crises in Greece and Ireland back in the headlines, the euro again is coming under pressure. After hitting a high of $1.48 in early May, the European currency has now fallen below $1.40.

The euro’s strength over the past 11 months took many investors off-guard. Less than a year ago, it traded as low as $1.18. Many pundits predicted it would soon fall to parity with the U.S. dollar.

The best way to profit from the euro’s decline is through the Proshares UltraShort Euro (EUO). This ETF moves twice (200%) the inverse (opposite) of the daily performance of the U.S. dollar price of the euro.

Because the movement is based on the daily calculation of the euro’s movements (I’ll spare you the math), this ETF won’t behave the way you may expect.

Still, EUO is up 10.87% since it bottomed in late April, and also is trading above its 50-day moving average to the upside for the first time since January.

Graph
3. PowerShares DB USD Bullish Fund (UUP)

The U.S. dollar is the global currency everyone loves to hate. But that’s nothing new. I remember in the mid 1980s when I tried to pay a fine on a metro in Munich, West Germany, with U.S. dollars. The conductor threw my dollars back at me, cackling to his colleague that the U.S. dollar was worthless. (The U.S. dollar hit a record high against the Deutschmark a year later.) So those wishing ill on the U.S. dollar are nothing new.

Yes, ballooning U.S. government debt and reckless spending on soaring entitlements bode poorly for the U.S. dollar in the long run. But as the financial meltdown of 2008 showed, when the markets get nervous, investors still rush into the U.S. dollar. No wonder that after hitting a multi-year low, the U.S. dollar has rallied 4% since its lows on April 29.

You can profit from the U.S. dollar’s rebound by buying the DB USD Index Bullish ETF (UUP), which seeks to track the price and yield performance, before fees and expenses, of the Deutsche Bank Long US Dollar Futures index. Last week, this position shot through its 50-day moving average for the first time since January.

Graph

4. iShares Barclays 20+ Year Treasury Bond (TLT)

The same argument that supports the U.S. dollar applies to U.S. Treasuries. For all the worries about the U.S. fiscal health — a “negative” outlook on U.S. government debt from S&P; China reducing its U.S. Treasury holdings; and the U.S. Congress unable to implement significant budget cuts; U.S. Treasuries remain the ultimate “safe haven” asset when Mr. Market swoons.

If there is one constant in the markets, it’s that when markets go down, U.S. Treasuries go up. PIMCO boss Bill Gross has bet big against U.S. Treasuries, expecting QE2 to pull the rug out from under the U.S. Treasury market. Time will tell. But betting on U.S. Treasuries has proven to be a robust bet during bouts of market nervousness.

The iShares Barclays 20+ Year Treasury Bond (TLT) is up 3.43% this past month, and is trading above its 50-day moving average.

Graph

5. S&P 500 VIX Short-Term ETN (VXX)

Savvy traders know that when markets go down, the only thing that goes up is volatility. And volatility is measured best by the VIX — the “fear index” — a measure that calculates the expected future volatility of markets over the next 30 days.

The VIX had reached almost record lows before the recent sell-off. That signaled a level of complacency in the market not seen since before the financial meltdown. This change occurred rather abruptly over the last few days, as the VIX has jumped to over 20 for the first time in two months.

In absolute terms, the current level of the VIX is not particularly alarming. After all, the VIX hit 46 last May — during the last serious crisis in Greece — and 23 last November, when the Irish bailouts dominated the headlines.

Sadly, S&P 500 VIX Short-Term ETN (VXX) has done a poor job in accurately reflecting the movement of the underlying VIX. And as the chart below shows, the long-term trend is still firmly down. Nevertheless, this position should jump if the market sell-off gains momentum.

Graph

So, if you’re worried about a market meltdown, and you’re confident in your ability to time the markets, a combination of these positions should help to protect your downside.

But remember, markets can snap back as quickly as they sold off. So make sure you have an exit strategy in place for when market sentiment turns upward.

Sincerely,

Nicholas A. Vardy
Editor, The Global Guru

P.S. The market’s recent sell-off nothwithstanding, I’m confident that a handful of “global megatrends” will generate big profits for investors in the future. I discussed five of these megatrends at my recent presentation “5 Global Megatrends That Will Make You a Fortune in 2011” at the Las Vegas Money Show. You can download a copy of the presentation for free by clicking HERE. If you like what you see, check out my monthly investment service, The Alpha Investor Letter, which includes these, and many other “red hot” investment picks.

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Written By

Nicolas A. Vardy is the London-based International Economics Correspondent for Human Events.

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