Macro Tsimmis

intelligently hedged investment

Archive for September, 2011

BUY ProShares Short S&P 500 (SH)

Posted by intelledgement on Fri, 23 Sep 11

We are increasing our short position here as a hedge against the increased risk of a major sovereign debt default—or potentially a series of defaults—in Europe that could negatively impact international banks (in Europe, the Americas, and Asia) and lead to a credit freeze similar to the one we experienced in 2008. As we have in the past, we are going with the Proshares Short S&P 500 (SH) ETF, which “seeks daily investment results, before fees and expenses, that correspond to the inverse (opposite) of the daily performance of the S&P500® Index.”

Previous SH-related posts:

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SELL PowerShares DB US Dollar Bearish ETF (UDN)

Posted by intelledgement on Fri, 09 Sep 11

OK, this move is going against the macros. Everything we said when we took this position back in October 2010 still applies, and then some. The US government continues to extend-and-pretend with a vengeance. Just last night, President Obama proposed another $450 billion amalgam of temporary, emergency salves for the sundry symptoms assailing our teetering economy, without the faintest hint of of any effort to cure the actual disease—systemic malinvestment driven by out-of-control banksters and corporatists whose incentives have become misaligned with the greater good of humankind. No surprise, as Obama’s biggest contributors have always been and still remain those very same guys.

So—among other bad effects coming sooner or later—the dollar is toast, given the compulsion of the government to keep printing more in their pathetic efforts to push on the stimulus/bailout string.

However, there is no chance of that happening this month. In contrast, that is, to the Euro, which could potentially be undone depending on how things play out with Greece, Italy, and Spain. If the Eurozone comes completely unglued and the Euro collapses, the dollar is likely to (temporarily) benefit as a (relatively) safe haven play. If that happens, we will have an opportunity to get back into UDN at a much lower price point.

Of course, it’s possible that the Eurozone could expel the troubled peripheral economies and we could end with a strengthened (temporarily) Euro. In which case, dumping UDN here will prove to be unnecessary, and possibly even cost us. But it is unlikely to cost us much to get back in under those circumstances—there is no immediate reason for the dollar to plummet in value—whereas if the Euro collapses—which appears to be the more likely scenario anyway—we could see substantial dollar strengthening.

Thus when the micros—in this case, the potential imminent collapse of the Euro and concomitant short-term effects —overwhelm the macros—long-term destruction of the dollar—stepping aside is the prudent play.

Previous dollar short-related post:

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BUY ProShares Short Financials (SEF)

Posted by intelledgement on Tue, 06 Sep 11

The bankster royalty are still parading down Main Street in the altogether—clothed with balance sheets crammed with chimerical toxic assets that their captured regulators allow them to carry at par when in reality they are worth next-to-nothing. The bought politicians insist that the clothes look great, and warn us that if we demur, it will be the end of the world. But more and more unruly little boys are insisting on the truth: the emperor has no clothes. It is only a matter of time before the crowd catches on.

It is the European banks that are the most exposed here. If you subtract from their mythical balance sheets the bad sovereign debts they have collected in the past few years and the bad mortgage-backed securities American banksters peddled to them in the last decade, there are several who would be insolvent. The central bank authorities are racing around handing out clouds of free money and distributing dark glasses to market participants, hoping to mask the naked truth a little longer, but any stray ray of sunlight at an indiscreet moment could reveal the truth and start a Lehman/Bear Stearns style bank run.

And of course, the US banks are integrated into the mess big time. If more than one or two Euro banks roll over, a cascade effect is likely. Even short of that, the risk levels are way up here. The stakes were raised considerably last Friday after the market close, when—in a surprise move—the U.S. Justice Department filed suit against 17 banks for fraud in the peddling of mortgage-backed securities.

Thus it is prudent to go short here. Our instrument of choice here is the Proshares Short Financials ETF (SEF), which utilizes short equity positions, futures contracts, options on futures contracts, securities and indices, forward contracts, swap agreements, and similar instruments in pursuit of “daily investment results, before fees and expenses, that correspond to the inverse (opposite) of the daily performance of the Dow Jones U.S. 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 1%…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.

Over time, because of the way the SEF ETF is designed (to match the daily performance of the index), it has an inherent negative bias, and therefore exhibits a significant tracking error. The problem is that on days the Dow Jones index moves up, the ETF tends to lose relatively more ground than it gains on the days the index moves down. The fund debuted in July 2008 and is down 39% since then…while the Dow Jones U.S. Financials Index over the same time frame is down 43%. As we would expect the SEF to be up 43%, this is a tracking error of a whopping 82 points over three years. Point being, this is not a fund to hold over the long term, because even if the Financials decline, your performance is not likely to reflect that. (Read more about inverse and leveraged fund tracking errors here.)

However, during periods when the financials declines sharply over a short time period, the performance of the SEF has reasonably closely met expectations. And we believe such conditions are likely here.

In the past we have used the ProShares Ultrashort ETF (SKF) to cover this base, but the tracking error of that fund—which is down 71% since inception in February 2007 while the DJ index is down 69%—is even worse at 140 points in four-and-a-half years. The SEF falls well below our preferred benchmark levels for liquidity—only $115 million in assets when we should prefer a minimum of $1B and only 188 thousand shares traded daily on average when we like to see a minimum of one million—but we are holding our noses here and diving in as a hedge against a financial sector meltdown.

Previous financials short-related posts:

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