Macro Tsimmis

intelligently hedged investment

SELL MSCI Hong Kong Index (EWH)/BUY UltraShort Financials (SKF)

Posted by intelledgement on Thu, 26 Jul 07

LOL being an economist is tough; not only are you expected to get the vector right, but the timing, too. We investing folks know that the former is a lot easier to perceive than the latter (which is not to say picking the vector is easy, either).

“Sales of new homes dropped more than expected in June, while orders for long-lasting U.S.-made goods were weaker than analysts thought, according to reports on Thursday that raised fresh concerns about economy,” according to a Reuters report today. And the markets are down across the board.

We have been expressing deep concern about the world economic outlook in general and the USA in particular for some time here, but as to the timing of the way things play out…it could be just as surprising to us as to anyone. We still think the big storm is most likely to hold off until at least late 2008 and quite possibly longer…but the risk of serious problems arising sooner has just increased…as we expect it will continue to do so, given that the situation is steadily deteriorating.

Accordingly, we have decided to take some money off the table on the long side and redeploy it on the short side. EWH is up for us overall this year, but it lags our other emerging market ETF positions performance-wise, which puts it at greater risk of turning sour. We are trading it in for for another ETF that is inversely tied to the Dow Jones U.S. Financials Index. We anticipate that even if the the USA consumer continues to spend and the Chinese continue to support the dollar, the developing credit crunch and weakening real estate markets ensure conditions for the financial sector will be worse than average. On the other hand, if the deterioration in market conditions should dramatically gain momentum sooner than we expect—this year or next—then this investment is likely to perform better than most of the others currently in the IMSF (although in that circumstance, you can expect further changes in the lineup). We considered the alternatives of increasing our GLD position or going long a currency ETF in anticipation of a weaker dollar but currently folks are still selling gold to increase liquidity and the targeted financials short play seems more likely to provide superior performance than a long play on another fiat currency.

The UltraShort Financials ETF utilizes leverage technique—futures contracts, options on futures contracts, securities and indices, forward contracts, swap agreements and similar instruments—to mimic the inverse of twice the daily performance of the Dow Jones US Financials Index. That is, if the fund managers meet attain their objective, on a day the DJ average goes down 1%, this fund should go up 2%…and vice versa. This DJ index represents banks (about two-thirds) and general financial groups (one-third), and the positions of the ETF reflect that distribution.

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