Market Waterfall Fast Approaching: How To Benefit!

All signs point to an imminent, violent and downward move in the stock market.  Fortunately, as a reader of "Marko's Take", not only can you AVOID it, but you can BENEFIT from it!

First, let's go through the reasoning.  The Dow Jones Industrial Average (Dow), recently broke a very reliable chart pattern known as a "rising wedge" or "bearish wedge".  This pattern is characterized by a series of higher highs and higher lows, but the pattern of highs and lows eventually cross, forming an upward sloping triangular shape, or "wedge".

As the market moves to the apex, or point of crossing, it can only do one of two things - break up or break down.  Normally, these patterns break down and when they do, it is highly likely that a key reversal has taken hold.

Second is the sudden increase in "volatility".  Normally, a healthy and rising market, NOT in a mania, will be characterized by low volatility or a small amount of either day-to-day fluctuation or intra-day fluctuation.  A falling market will typically experience rising volatility as investor panic sets in.  In the last two weeks the market has broken a year long trend of falling volatility.  It has suddenly spiked higher. 

Low volatility is the result of good liquidity.  In other words, as there is a better balance between buyers and sellers, market movements are dampened.  When liquidity is low, volatility rises as sellers swamp buyers and larger movements are required to entice buyers to step in.

Finally, this breakdown in stocks would be consistent with the oncoming double dip of this DEPRESSION.

So, how can you benefit?

There are many interesting alternatives - especially "inverse" Exchange Traded Funds (ETFs) and Exchange Traded Notes (ETNs).

So, it depends on how aggressive you want to be.  Inverse ETFs and ETNs come in a variety of flavors.  ETFs often act as inverses by a factor of 1 - meaning that if an index drops by 1% in a day the ETF will rise by 1%.  ETFs or ETNs, on the other hand, can also use leverage and MAGNIFY the effect.  For example, ETFs and ETNs exist with both double and triple leverage.  A triple inverse ETF or ETN will rise 3% for every 1% drop in the market on a daily basis.

Some ETFs that can be employed to create a short position can be found here (http://tradermike.net/2007/03/list_of_inverse_short_bear_etfs), as can an excellent selection of double inverse vehicles.

For some of the more aggressive ones they can be found here (http://www.stockrake.com/3x-triple-leveraged-etfs~2008~11.html).

Naturally, I cannot recommend anything but merely provide you with the information.  I am no longer a Registered Investment Adviser (RIA) and need to make this disclosure.  Each of these vehicles carry tax consequences and you should consult with a real RIA, as opposed to taking my word for it.

It's a crying shame that the country is on the cusp of entering perhaps its darkest period.  But that doesn't mean that you need to go down the tubes with it.

On Monday, we'll cover the new employment data released last Friday and its implications for the economy.

Marko's Take

Preparing For The Coming Waterfall

Now that we've laid out the background as to why investors need to re-assess tactics, we can finally move on to suggesting some options.  This is the hard part.  For one, every investor's risk tolerances and goals are unique.  Second,  factors such as age and exposure to other risks need to be taken into account.  Since we can't do this on an individual basis for Marko's Take, we'll take a "rules-of-thumb" approach using the general categories of risk:  "conservative", "moderate", "aggressive" and "very aggressive".

As a disclaimer, I'd like to say that I am NOT currently a registered investment advisor and am only offering an OPINION.  You should NOT rely solely on what I've written, but possibly use this in conjuction with YOUR registered advisor and/or other investment professional before adopting anything written here today.

For investors who might believe themselves to be conservative, the best approach, in my opinion would be to go to cash and wait the storm out, before making any further commitments.

Moderate investors have more options.  At at minimum, they should lighten on all long exposure.  My own rule-of-thumb would be to reduce investments by 50%, put the rest in cash and wait the storm out.

It starts to get tricky when we approach some sort of aggressive status.  I would still recommend a reduction of AT LEAST 50 % to all long positions, coupled with either a hedging strategy utilizing Exchange Traded Funds (ETFs) or Exchange Traded Notes (ETNs) to place some chips on the downside.  For Gold investors, the ETN which goes by the symbol DZZ would do quite nicely. It's a double-inverse play on the price of Gold with a leverage of 2.0. In other words, DZZ is designed to GAIN 2% for every 1% loss in the price of Gold on a daily basis.

Before I go further, it is extremely important to note that ETNs involve "counter-party" risk, and any use of them should be limited to the very short term and they should be scaled back if they indeed start to generate gains.  Unfortunately, if you begin to make decent money in an ETN, they get VERY volatile.  Therefore, I would view them entirely as a very short term play.  Diversify them, and take money "off the table" frequently.

For playing the downside in stocks, my personal view is the financial sector is in the greatest trouble AGAIN, and some very interesting ways of playing the waterfall exist. My personal favorites are FAZ, a triple-inverse ETN to the financial sector, or SKF, a double-inverse ETN. 

There also exist many ways to play the downside in various indicies like the Dow, Nasdaq, or Russell 2000 - an index of "small cap" stocks.  In waterfall situations, larger companies like those which make up the Dow or Nasdaq will normally perform better than the types of smaller companies which comprise the Russell. Therefore, I prefer to use TZA - another double-inverse play specifically designed to benefit from losses in the Russell 2000.

If you consider yourself very aggressive,  I would lighten up on all long exposure as much as possible and use some combination of the above mentioned ETNs to create a true downward playing portfolio.

Finally, we need to consider the "what if Marko is wrong again" scenario.  I believe that answer as to Gold is simple.  Use a material and sustained UPWARD breach of $1,100 as your guide.  I'd wait at least one day before taking action, and if such a breach does occur, I'll revisit Gold at that point.

As to stocks, I'd consider the 10,600 level of the Dow as my failsafe.  In other words, should the market suddenly reverse and rally upward through 10,600 then my cascading waterfall scenario would likely become null and void.  Again, should that occur or look like it might, I'll cover stocks.

Finally, it appears volatility is ready to jump and unless you have the stomache to deal with it, I'd sit this dance out.  The market may "bounce" on Monday, or it could "gap" lower, I have no idea.

I hope, after reading this, you're ready for Monday. 

Good luck!  If you have any questions, agree or disagree, you know what to do.  TAKE ME ON!

Marko's Take

Commodity ETFs As A Way To Play The Coming Hyper-Inflation

Before launching into this essay, we must first make a distinction between an ETF (Exchange Traded Fund) and an ETN (Exchange Traded Note).

An  ETN is a senior, unsecured, unsubordinated debt security issued by an underwriting bank.  Similar to other debt securities, ETNs have a maturity date and are backed only by the credit of the issuer!  Therefore, they carry "counter-party" risk, as do derivatives.

ETNs are designed to provide investors access to the returns of various market benchmarks. The returns of ETNs are usually linked to the performance of a market benchmark or strategy, less investor fees. When an investor buys an ETN, the underwriting bank promises to pay the amount reflected in the index, minus fees upon maturity. Thus, an ETN has additional risk compared to an ETF - upon any reduction of credit ratings or if the underwriting bank goes bankrupt, the value of the ETN will be eroded.

For those reasons, I think ETNs should be avoided while ETFs are much, much, safer.

The number of ETFs and ETNs for that matter, have exploded in issuance and continue to do so.

If you want to play various commodities or even currencies, a number of ETFs exist for that purpose.

In the Metals sector, ETFs exist for Platinum (PPLT), Palladium (PALL), Gold (GLD) Silver (SLV) and Gold and Silver Mining Stocks (GDX and GDXJ).

As to Agriculture, one can play overall agri-business with DBA.  A rather large variety of  currencies have ETFs.  One can invest in the Australian Dollar (FXA), Brazilian Real (BZP), Canadian Dollar (FXC), Chinese Yuan (CYB), Euro (FXY), Indian Rupee (ICN), Mexican Peso (FXM), Pound Sterling (FXB),
Russian Ruble (XRV), South American Rand (SZP), Swedish Krona (FXS) and Swiss Franc (SXF).

Other commodity-related ETFs include Oil (USO) and (USL), Gasoline (UGA), Heating Oil (UHN) and Natural Gas (UNG).

Before you dive-in, make sure that the ETF does indeed accurately track the underlying index!  One ETF that has done an abysmally poor job is USO, which has embarrasingly underperformed oil prices.  I've also expressed concerns about GLD in prior essays.

A couple of other interesting ETFs include meat products (MOO) and water resources (PHO).

Note:  I'm NOT recommending any of these.  The only ETF I have experience with is TIP, which mimics Treasury Inflation Protected Securities (http://markostake.blogspot.com/2009/12/tips-on-grabbing-higher-yields.html) and GDXJ..

Tommorow, we'll cover some interesting ways of hedging against inflation without going through the ETF route.

Thanks for reading!

Marko's Take