Thursday, January 31, 2008

Oh, the Mockery

You have to wonder whether there's a better way to manage your nest egg

By Alex Roslin
Thursday, January 17, 2008

The Montreal Gazette
Business Observer

Is it just me, or are the markets acting crazier than a zombie in a horror flick?

I bet many readers looking at their investments are thinking the same thing: Surely, there's got to be a better way to manage my little nest egg.

Here's one common investing mistake I've made from time to time. Maybe you have, too.

It all starts with some gushing news about how China or Florida real estate or some other ripping market has zipped up, up and away, straight to the heavens, leaving you wretchedly back on boring Earth with your miserably languishing investments.

If only you had realized months ago the lofty potential of this on-fire market, like everyone else on the blessed planet somehow did, why, your toes would already be sinking into the soft white Caribbean beach, instead of hiding in wool socks and boots.

So what do you do? You probably jump in anyway, of course. Maybe, just maybe, you tell yourself, egged on by bullish analysts who say the market is headed far higher, you can still catch some of the ride.

Then what happens? More often that not, the market sells off sharply. But don't worry, the analysts will say. It's just a minor correction, a sorely needed breather before the market flies to even more rarefied heights.

In fact, the selloff is really a godsend, a chance to load up even more at a lower price. What luck! Investing is so easy.

So you buy another piece of the action. At some point, though, it dawns on you the "pause" is looking more like something else -- a true correction, a rout even. You avoid the newspaper and TV news, not wanting to learn the bloodbath has worsened.

You're soon sick with self-doubt, paralyzed into indecision. Should you dump it all? Should you hold because the selling eventually must end, must it not? Or maybe you should even add to the doomed investment, seeing as how it's now so ridiculously cheap?

Eventually, you reach what traders call the "puke point." You just need the horror to end. So you sell.

Of course, you know the rest. Here, precisely, is when the carnage does stop, and the market joyfully bounds back. Oh, the mockery. You wonder if the raison d'ĂȘtre of the markets is to mess with your head and steal your last penny.

Sound like a familiar scenario? If so, take heart. You're not alone. We all know we should "buy low and sell high," but in reality, we often find ourselves doing exactly the opposite: buying high and selling low.

This dynamic has, in fact, been the very fuel of the markets for centuries, since well before modern history's first major speculative bubble - Holland's "Tulip Mania" of the 1630s, when the price of a single tulip bulb shot up to as much as 40 times the average yearly income, then crashed, devastating the Dutch economy for years.

Today's investors, seemingly better informed, still make the same mistakes. The dot-com disaster is one example. Now, it's happening yet again with the U.S. real-estate catastrophe.

It reminds me of what Frank Borman, CEO of Eastern Airlines, once said: "Capitalism without bankruptcy is like Christianity without hell." (Eastern went bankrupt three years later.)

Curious about all this, I recently studied data, available from the U.S. Commodity Futures Trading Commission, on how small-time traders perform in the futures and options markets.

I found something curious but sad. The crowd isn't just wrong in the markets; it's so consistently wrongly positioned in the markets, you can reliably make good money doing the opposite.

I found you could have beaten buying and holding the NASDAQ 100 index by 10 times since 1995 if you had bought the index when the small traders hit specific extremes of pessimism and sold the index short when they got excessively bullish. (Selling a security short is a way to make money when it falls in price.)

If you're wondering how the small traders stay solvent, the answer is most probably don't for long. But history shows there's always a new generation of gamblers lining up to feed their offerings into the hungry maw of our free-market system.

So what can you and I do? I think it's important to educate ourselves about how the markets really work and try to learn something from our mistakes.

As author Stephen Covey wrote, "If we keep doing what we're doing, we're going to keep getting what we're getting."

But like a zookeeper feeding a tiger, never forget your humility. After all, history is against you.

Monday, January 28, 2008

Swinging to a New Strategy

Many Canadians are playing the markets like never before thanks to a fast-growing class of leveraged exchange-traded funds

Monday, January 28, 2008
The Montreal Gazette

As markets yo-yo crazily up and down, growing numbers of Canadians are turning to a risky new investment strategy that used to be the preserve of professional speculators and big investment firms: leverage.

Ordinary investors can now play market swings like never before thanks to a fast-growing class of leveraged exchange-traded funds.

ETFs are like mutual funds that trade as stocks on an exchange. They seek to match the moves of an underlying market like the S&P/TSX composite index or gold. Unlike mutual funds, they are passively managed and charge minimal management fees.

The universe of ETFs has exploded in recent years in Canada and the U.S. as mutual funds have come under fire for exorbitant fees and lackluster returns.

The new leveraged ETFs offer yet another choice. They promise to double the gain-and-loss of the underlying market.

In other words, if the S&P/TSX 60 Index goes up $1, the related ETF aims to rise $2.

Confused? Here’s yet another twist: some of the new leveraged ETFs seek to double the inverse of an underlying market. So when the TSX 60 drops $1, the ETF goes up $2.

Horizons BetaPro, the Toronto-based financial-products company that is the only provider of leveraged ETFs in Canada so far, launched four new leveraged ETFs last Wednesday covering gold bullion and global mining stocks.

The company’s Gold Bullion Bull Plus ETF (symbol HBU) uses gold futures contracts to achieve two times the change in the price of gold.

Meanwhile, its Gold Bullion Bear Plus ETF (HBD) seeks to do the opposite—double the inverse of moves in the gold price.

Earlier in January, BetaPro launched new leveraged ETFs covering the price of crude oil and natural gas. And the company plans to kick off two more funds in early February for a basket of agricultural commodities—soybeans, wheat and corn.

The new products will bring the company’s leveraged ETF offerings to 18.

As the only leveraged commodity ETFs in the world, the products are drawing interest internationally, with assets in the company’s funds growing more than fivefold to $750 million in 2007, said president Howard Atkinson.

Horizons BetaPro offers still other leveraged vehicles in its family of mutual funds, including ones that seek to double changes in Canadian bond prices, the NASDAQ-100 Index and the U.S. dollar.

The company has hired ProShares Trust, which has launched several dozen leveraged ETFs of its own in the U.S., as the portfolio manager for its ETFs.

“Since 1999 to 2000, we’ve seen some good (market) upswings, but also good old-fashioned bear markets. In those environments, which we seem to be in now, our product can be quite useful,” he said.

But just how practical are leveraged funds for ordinary folks? Analysts have mixed feelings.

“For most investors, they’re not worthwhile,” said David O’Leary, manager of fund analysis at Morningstar Canada, a leading investment-research firm that rates ETFs and mutual funds.

“They’re very tough to own. They tend to be extremely volatile so it’s harder to stay along for the ride. What we see time and again (with these funds) is people buying high and selling low. People tend to get more greedy and excited.”

They’re more suitable, he said, for “fairly knowledgeable investors trying to play a trend.”

Jeffrey Ptak, Morningstar’s director of exchange-traded securities analysis in Chicago, agreed. In early January, he wrote a report on the worst new ETFs of 2007. One of his top picks: leveraged ETFs.

“In my opinion, they are a terrific way to blow an investor up,” he said in an interview. “For long-term investors, they have tenuous value from a risk-reward standpoint.”

Ptak’s main concern: most of the time, the ETFs haven’t actually succeeded in doubling the return of the underlying market.

For example, since it started trading on Jan. 10, 2007, BetaPro’s 60 Bull Plus ETF (symbol HXU) gained 18.5 per cent in the subsequent year. That’s 58 percent more than was gained by the unleveraged iShares Canadian S&P/TSX 60 Index Fund, which went up 11.7 per cent over the same period.

A great return, but not double.

On the other hand, BetaPro’s Energy Bull Plus ETF (HEU) lost 59.6 per cent between its launch in June and last Wednesday, while the iShares Canadian S&P/TSX Capped Energy Index Fund (XEG) lost 23.8 per cent.

That works out to a loss 150 per cent greater for HEU than XEG—more than double.

So in that case, a savvy investor might wonder, did BetaPro’s leveraged inverse energy fund (HED) make a killing? Ironically, no.

HED did gain a tidy 40.9 percent since last June. But that’s 72 per cent more than what was lost by XEG—again, short of 100 per cent.

Atkinson, Horizons BetaPro’s president, said the shortfalls arise from the mysteries of compounding and volatility. On a daily basis, he said leveraged ETFs are, indeed, able to exactly double the underlying index.

But results are less predictable over longer periods. When markets are zigzagging up and down, for example, leveraged ETFs tend to achieve less than a doubled return.

Conversely, when a market is in a longer trend, a leveraged ETF can actually more than double the underlying index.

Atkinson said investors can get around this conundrum by regularly rebalancing their holdings. Rebalancing is especially recommended in more volatile markets if an investor wants to be sure to achieve a doubled return, he said.

Horizons BetaPro offers a tool on its website to help investors figure out how much rebalancing is needed based on their holdings.

Don Vialoux, an Oakville, Ont.-based market analyst and author of the website, said leveraged ETFs are ideally suited for shorter-term traders seeking to play a market trend.

But they can also be useful to hedge a long-term portfolio when markets take a tumble, he said.

“If you’d used that strategy over the past two weeks, you would be a happy camper.”

Monday, January 21, 2008

Riding out the market mayhem

There’s growing unease among analysts that the 5-year bull market may finally be dead

Monday, January 21, 2008
The Montreal Gazette

[NOTE: The chart on the right accompanied this story. Click to enlarge.]

Six months of market chaos stoked by the U.S. real-estate disaster have left many investors and analysts exhausted, wondering which way is up.

While safe-haven gold and government bonds have roared to record or multi-year highs, most major global stock markets have punched through their lows of last November.

Last week, they hovered around the sad-sack levels set back during the credit crunch of last August.

The S&P/Toronto Stock Exchange composite index seesawed below and above the 13,000 level in wild trading last Wednesday and Thursday, down 11 percent since its peak in October.

The Standard & Poor’s 500 index was off 13 percent, while the more volatile U.S. Semiconductor Index has lost 30 percent.

Even the once mighty banks are getting crushed. The benchmark KBW U.S. Bank Index is down over 25 percent since last September.

More importantly from the viewpoint of chart watchers, banks never saw any of the recovery that the broader markets enjoyed last autumn, instead flinging themselves down lower and lower while gruesome revelations emerged about the extent of the subprime fiasco.

Canadian banks are on somewhat more solid ground, but they, too, have fallen a head-turning 14 percent—more than the average stock in Toronto—since October.

So far, most of the major indices have yet to bust down below the major uptrend lines they have formed since 2004. The correction has seen the TSX and S&P 500 drop down to touch those key lines, but so far they haven’t been violated.

As well, by the usual definition of a bear market—a 20-percent drop from the peak in prices—most major indices are still officially in a bull.

But some sectors haven’t fared so well—a warning sign, say analysts, for the broader markets.

Last fall, the Russell 2000 index of U.S. small companies and Japan’s Nikkei Stock Average both crashed well below their respective uptrend lines. And the KBW bank index ended its uptrend last summer.

It’s all got a growing school of uneasy analysts brooding that the five-year-old bull market may finally be dead.

“I can’t recall ever a year starting this bad,” says Stephen Vita, a professional trader in Bradford Woods, Pennsylvania.

The exploding market volatility reminds him a lot, he says, of the turbulence he saw when the last bull market topped in 2000, as the dot-com bubble started to unwind.

In some ways, the current turmoil is even worse, he says, and that’s caused him grief when trying to make market predictions.

Vita went into last Wednesday thinking, like many traders, the market was poised to break down forcefully. Monday and Tuesday had seen a rally attempt fail and turn into a sharp drop for equities.

At 9:32 a.m. Wednesday morning, two minutes after the opening bell, Vita put 50 percent of his managed funds into action selling short the S&P 500 index. (Selling a security short is a way to profit when it declines.)

Initially, it was a good call. The S&P 500 fell. But an hour later, the index started to shoot back up and, eventually, it clawed its way into the black.

At 1:50 p.m., having lost most of his early gain, he wrote on his website, “Momentum trading is a great game for as long as it lasts, and if you don’t know when that point arrives they will carry you out.

“Actually that isn’t really true. They won’t take the trouble to carry you anywhere and will just bury you under the trading room floor.”

By 2:31 p.m., the index rallied even higher, this time putting his position solidly in the red. He closed his position with a 0.30-per-cent loss for his total portfolio.

Just minutes later, however, the rally fizzled and the index tumbled down to close back in the red.

“What a sick beast this is,” Vita wrote on his site.

In an interview later he said, “It was a day very much like 2000 when you get yanked around. Actually, it’s funkier than it was back then. There were more rallies (then) you could play with more confidence than this.”

While Vita said he’s not big on trying to forecast market direction, he says most signs suggest the market has, indeed, entered a bear.

That means any rallies in coming weeks or months will likely stop before reaching new highs, followed by declines that send prices lower, perhaps much lower. The key level to watch, he says, is last August’s lows.

“If they take out the August lows, then you’ve got to figure it may not go down just 10 percent. It could go down 20 or 30 percent.”

John Roque, head of technical analysis at New York investment bank Natixis Bleichroeder, agreed it’s more likely markets will make new lows before making any new highs.

While Roque, like Vita, was reluctant to issue longer-term predictions or label himself bullish or bearish, he said the most likely scenario is a short-term bounce upward into March because stocks have gotten so oversold, but he doubts any rally will forge new highs.

Key to watch on that rally, he said, will be what happens to the hitherto market leaders, like commodities. If they maintain vigor, he said, “the fears of a recessionary threat may not be as serious as we thought.”

More suspect, he said, would be to see currently downtrodden stocks like financials suddenly assume market leadership. That, he said, may mean a new market dynamic has emerged in which any rally is likely to be “more ephemeral” and short-lived.