3 Reasons the Market is Getting Smacked, and a Few Things You Can Do About It


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By ETF Stocks

Stocks are taking it on the chin today. Why?

Yesterday, Federal Reserve minutes hinted that it might be ready to sober up the intoxicated free money crowd on Wall Street. The FOMC ink suggested the economy is growing well enough on its own and doesn’t need more stimuli. However, two Mondays back, Chairman Bernanke said more Fed aid might be needed to avoid a structural employment problem. Chalk the difference up to the things that make you go hmmm.

Adding to the pile of doubt is an economically deteriorating Euroland. Today’s Spain debt auction was less than enthusiastic; the EU zone is suffering from rising unemployment, and the little engine that could, Germany, is watching its economic base, manufacturing, decline.  The continent is on the verge of or in recession already.

It's wishful thinking that the United States can “decouple” from the rest of the world. While, that might have been possible following WWII, it is not today. Europe’s problems are already spilling over into China as their GDP growth forecasts have been trimmed.

It’s difficult to envision a hard/soft economic landing in China and a European recession while the U.S. economy bobs along at 2.5% GDP growth – ain’t gonna happen.

The combination of no more Federal Reserve Monopoly Money and a global economic slowdown dent the two pillars of the stock market’s rally, easy money and rising profits. In fact, Wall Street believes first quarter 2012 earnings will be flat relative to 2011 and that six of 10 sectors will see profits retreat.

Clearly, the first truly ugly day in more than three months does not make a bear market. Rather, it’s the first hard buck of the bull that could shake investors out of their saddle of comfort.

However, there is one big unshakeable image stuck in ETF Stocks mind. Our weekly scan of industry charts showed only six sectors in the bull side of the ledger and 25 in the bear’s column. It is the biggest discrepancy we have seen since last summer’s double dip and Greece worries.

So, what are investors to do just in case the creaking noises we hear on Wall Street today turn into cracks or something worse?

Last week we wrote about the protection or downside insure provided by inverse ETFs. Another possibility is to implement what ETF Stocks coined as a ZERO Trade.

For example, since the indexes tend to fare better than individual stocks or sectors in corrections, investors could purchase an index based exchange traded fund like PowerShares QQQ (QQQ). Of course, we realize that if the market goes down, so will QQQ, but next up is part B to our ZERO Trade.

After buying say $10,000 of QQQ, we short an equal amount of a sector that appears weak and should underperform in the near-term. Chemicals would be a perfect example. Not only does the sector’s chart look bad; chemicals were one of the few industries that reported weakness in this week’s ISM Manufacturing Survey.

While there are no industry specific Chemicals ETF, a Basic Materials ETF like Materials Select Sector SPDR (XLB) could be a solid substitute.

Or, you can short a few of the high flying stocks within the Chemical sector. If the market takes some water out of the tub, the equities floating along at the highest altitude have to most room to drop.

ETF Stocks scanned for all chemical companies with a relative strength reading above 65, which puts the stocks near overbought readings. We found four chemical companies that met our criteria and could be ready for some near-term profit taking.

Aceto Corp. (ACET)

Airgas Inc. (ARG)

American Vanguard Corp. (AVD)

OMNOVA Solutions Inc. (OMN)

To complete the ZERO Trade, you would short some combination of these stocks to match the $10,000 used to buy QQQ. Hence the name ZERO Trade as your account is debited and credit $10,000 when all the trades are executed. As long as PowerShares QQQ outperforms the stocks or Materials Select Sector SPDR, it doesn’t matter which direction the stock market takes, the trade will profit (minus fees, commission, margin interest…).

Investors worried about the market might consider employing this hedging strategy. It’s very popular among the hedge fund crowd in times of uncertainty, except they call it pair trading and worry about things like correlation. However, nowadays, every asset class seems to be highly correlated.  

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

This article appears in: Investing , ETFs , Investing Ideas , Stocks
Referenced Stocks: ACET , ARG , AVD , OMN , XLB

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