Editor's note: John Lounsbury is a new contributor to TheStreet.com who will provide business news commentary and tips about how to invest off the news. Lounsbury runs a private business offering financial planning and investment advice for families. He previously served as a licensed representative for MONY Securities from 1992 to 2000 and spent 34 years with IBM, including 25 years in R&D management. Real contrarians are brave people. The successful ones are brave at the right time. Stepping in front of a speeding train is much more foolish than brave. So if you are a contrarian and want to be successful, you must be able to discern the difference between a real speeding train and an illusion. We're here to help with that. Here are 10 potentially great contrarian moves for the next few months, using exchange-traded funds, or ETFs.
This could be the mother of all wipeouts if you make a decision to short gold and we finally get the big rally well above $1,000, as some have been predicting for almost two years. Such a rally could occur if the recent optimism about the economy and recovery turns 180 degrees and falls sharply this summer, with increasing doubts raised about the solvency of the U.S. and other developed countries. Just the opposite occurrence, a strong recovery with concurrent increasing fears of inflation, could also ignite a massive gold rally.
1. Sell GoldThe chart below shows the trading range of the SPDR Gold Shares ETF ( GLD) over the past two years. Gold has twice failed at $1,000 resistance, and an ideal put on a short position would be near $1,000. The closing price on Friday was about 6% below that level at $941.50. Selling gold may not be so contrarian. It was just reported that the analyst consensus year-end price for gold is $918, down 2.5% from Friday's close. If I were to make this trade, I would look for an entry above $960. If gold continues to rally above $960, I would try to follow it higher before shorting. If gold surges through $1,000 in the coming weeks, before I put on the position, I would call off the entire idea until I thought I could see a possible top. Note that picking tops in gold has been very tricky; recent downward reversals have been violent.
I feel that the scenario for gold to have a pullback is a "muddle through" summer, which could cause the fears of the two more extreme scenarios to diminish and result in a gold decline, perhaps to levels last seen in the fall of 2008. If shorting gold is your thing, I wouldn't go on vacation. Mind the store and get out if your position loses more than 10% from entry or 15% from the position high reached after opening the trade. Possible vehicles include shorting the heavily traded GLD (shown in the chart above) or buy the new UltraShort Gold ProShares ETF ( GLL).
In an environment where many are calling for interest rates to rise in response to massive efforts of the Fed to increase liquidity, buying bonds is a contrarian move. However, others are also recommending this, including Dave Rosenberg, chief economist at Gluskin Sheff Associates (and former chief North American economist at Merrill Lynch). So if you are on the wrong side of this trade, you will have some good company. An ETF for investment-grade corporate bonds is the iShares iBoxx Investment Grade Corporate Bond ETF ( LQD). To establish a hedged position, LQD can be paired with a short position in U.S. Treasuries (discussed in idea No. 10, below) to protect against a sharp rise in interest rates, under the assumption that the credit spread would narrow if long-term Treasury rates spike.
2. Buy Corporate BondsThe yield spreads between investment-grade corporate bonds and U.S. Treasuries remain at historic highs. See the following chart, courtesy of Bespoke Investment Group:
3. Sell Financial StocksThis looks like a major freight train barreling down the track at 60 mph. Just look at the chart for ProShares Ultra Financial ( UYG) from March into May: a three-bagger in two months. However, note the broken uptrend lines in May for (from the top) relative strength, price and MACD. These breaks of trend lines can sometimes be good alerts for possible trend reversals.
4. Sell Municipal BondsThis suggestion makes sense if the recession drags on for the rest of the year and the budget shortfalls in cities and states put downward pressure on municipal bond ratings. A well-publicized default or two could produce a panic selloff. Finally, if there is a recovery starting, rising interest rates could put downward pressure on muni prices.
Why do I say selling munis is contrarian? The first reason is that they have been rallying for months. A second reason is that more than a few people are recommending them as a good investment in a muddle-through environment where the recession doesn't get much worse or a weak recovery starts. In such a situation, U.S. Treasury bond rates may not rise significantly. One of my favorite analysts, Brett Steenbarger, said last week, "In a low interest rate environment, those tax-free yields have looked attractive to retail investors and, amidst hopes of economic stabilization, investors have been willing to move away from Treasuries and into munis." There are no ETF options that are short munis. The iShares S&P National Municipal Bond ETF ( MUB) can be shorted. Another possible short is the SPDR Barclay's Muni ETF ( TFI). Be aware that in shorting a dividend paying stock or ETF, you will have to pay any dividends that are issued while you are short. If you buy put options on either of these funds, you will have a short position with no exposure to paying dividends, but you risk losing the option premiums.
Note that the MACD and RSI trends are still clearly up. The one sign of potential weakness is the declining volume since early March. A possible entry point for going short oil would be when the MACD curve turns down. However, an entry trade at the end of March when the MACD started down (see blue ellipses) did not produce any significant opportunity for profit.
5. Sell OilHere is another potential 60 mph train that might be real. Just look at the weekly chart for the U.S. Oil Fund ETF ( USO), which has risen 46% since Feb. 26.
If the hopes for an end to the recession fade during the summer, it is possible that oil will trade down. If the current optimism for an end to the recession continues, oil could continue to trend higher. So, to consider this trade, you will have to watch economic news and sentiment as well as look for technical signals in the oil charts. Possible ETFs for shorting oil and oil related industries are the UltraShort Oil and Gas ProShares ( DUG), Short Oil and Gas ProShares ( DDG) and DNO International, a short companion to the U.S. Oil Fund, which has filed with the SEC but has not yet opened for trading. Of course, you could sell USO short or buy put options on USO.
6. Buy Health Care StocksHealth care stocks have been beaten down and have not rallied nearly as much as most other sectors since March 9. The primary reason for this is probably uncertainty about what the future holds for health care policy coming from Washington. The fear factor centers on what damage could be done to future prospects of pharmaceuticals and other health sector businesses if the stated policy objective of "bringing down health care costs" results in curtailing profits and future growth. What is being overlooked is that health care is and will continue to be a growing business. If policy objectives are met and tens of millions more people obtain health care coverage, these companies will simply add to the volume of products and services that are already destined to grow in an increasingly aging population.
The Vanguard Health Care ETF ( VHT), the Health Care Select Sector SPDR ( XLV), the PowerShares FTSE Rafi Health Care ( PRFH), the First Trust Health Care AlphaDex ( FXH) and Rydex S&P Equal Weight Health Care ( RYH) are all broad-based health care ETFs. There are many subsector ETFs, and there is even a leveraged short health care sector ETF, the Ultra Health Care ProShares ( RXL).
To short real estate, the Ultra Short Real Estate ProShares ( SRS) can be used. The companion leveraged long ETF is the Ultra Real Estate ProShares (URE). One note of caution here: SRS and URE generally should be used for short-term trading positions only. As with many leveraged ETFs, the attempts to provide daily tracking of indices leads to small tracking errors (many more negative than positive). Over time, these many small errors accumulate to produce major distortions.
7. Sell Real EstateNew housing construction starts are still contracting, inventories of houses on the market are still much higher than normal, foreclosures are continuing at a high rate, and a new bubble of adjustable-rate mortgage resets are scheduled, which may add to mortgage defaults. There may still be fallout in commercial real estate through the rest of 2009 and beyond. Investors have been trying to look through the valley to a sector recovery starting by the end of the year. If there is realization this summer that a recovery might be much further off, this beaten-down sector could fall further, even exceeding the lows of March. The rally from the early March bottom has seen the Ultra Real Estate ProShares ( URE) gain 69% (including dividend), but this rally may be failing at resistance shown (defined by November closing lows). The failure of the rally would be confirmed if MACD starts to reverse its current uptrend.
An example of the effect of the accumulated daily tracking errors is shown in the chart below. If each fund perfectly reproduced the index and the inverse of the index, investing equal amounts in each fund would produce a result differing from zero only by the net of dividends minus operational expenses of the two funds. The graph below, courtesy of Yahoo! Finance, shows that the result after one year would be substantially below break-even. (Note: The vertical percentage scales are logarithmic.)
In my opinion, the bears have a good case, and I am standing aside for the moment. The risk/return ratios are not very attractive. The potential gain looks like $6 (from $82 back up to $88), while the possibility of dropping back down to the lows around $72 would result in a loss of $10.
8. Buy The DollarThis is a trade for the brave, the foolish or the nimble (or all three). David Spurr argues that with a 50% retracement down from the December to February high (see chart below) on low volume, the dollar may be poised for a rebound. Spurr proposes buying the dollar on that basis. However, others do not agree, feeling that a different technical view of the chart brings the opposite opinion. The critical nature of the present technical position of the dollar charts is seen in the chart below (from Richard Russell), shown this week by Barry Ritholtz in The Big Picture. The head-and-shoulders top formation for the U.S. dollar, with current prices at the neckline, coming off the right-hand shoulder, makes this crunch time for technicians.
An ETF that rises with the dollar index is the PowerShares DB U.S. Dollar Index Bullish ( UUP), while shorting the dollar can be accomplished with PowerShares DB U.S. Dollar Index Bearish ( UDN).
So why would it be a contrarian move the short the S&P 500 and buy the Nasdaq? Isn't that just following the trend? The chart below shows why it could be considered contrarian. For the past month, the S&P 500 has outperformed the Nasdaq. Unless you think that will continue, you could bet on a reversal to the form of the last six months. This is contrarian with respect to the 30-day record but trend-following for the past six months.
Why would one put on such a trade? If you have high uncertainty about how the market will move but expect that one index is likely to outperform the other, you can try to profit from that difference while otherwise staying market-neutral. You can use the following ETFs to short the S&P 500: the Short S&P 500 ProShares ( SH) and the UltraShort S&P 500 ProShares ( SDS). The PowerShares QQQ ( QQQQ) ETF is long the Nasdaq, and the Ultra QQQ ProShares ( QLD) is ultra long (2X). The companion ETFs are S&P Depositary Receipts ( SPY) (long the S&P 500) and Ultra S&P 500 ProShares ( SSO) (ultra long), and for shorting the Nasdaq, you can use Short QQQ ProShares ( PSQ) and UltraShort QQQ ProShares ( QID) (ultra short).
9. Sell the S&P 500 and Buy the Nasdaq CompositeThe graph below shows that the Nasdaq has consistently outperformed the S&P 500 over the past six months.
10. Tie: Buy Treasuries and Sell Treasuriesa. The case for buying Treasuries: There is an old saying: "Don't fight the Fed." And the Fed has aggressive plans to support the price of U.S. Treasury securities in 2009.
Quantitative easing is expected to have the Fed buying up to $1.75 trillion of intermediate- and long-term Treasuries this year. China is also expected to remain very supportive, with additional purchases of short- and intermediate-term debt of at least $100 billion and maybe as much as $200 billion in U.S. Treasuries this year. Jamil Anderlini writes from Beijing in The Financial Times. On Monday he said:
This chart is quite bearish. Price trend is strongly down, with an attempt to rally just ended, apparently unsuccessfully. MACD is in a downtrend. RSI is low and pointing down. Three of the four most negative days in May have volumes of about double the average. May 21 (the next to last day in the chart) shows a massive "bearish engulfing" candlestick pattern. May 21 shows very small tails (up and down), indicating that there were no bulls fighting for the day, and TLT had a massive move down, from open to close, of about 3%.
But Chinese and western officials in Beijing said China was caught in a "dollar trap" and has little choice but to keep pouring the bulk of its growing reserves into the U.S. Treasury, which remains the only market big enough and liquid enough to support its huge purchases. In March alone, China's direct holdings of U.S. Treasury securities rose $23.7bn to reach a new record of $768bn, according to preliminary U.S. data, allowing China to retain its title as the biggest creditor of the U.S. government.If the hoped-for end to the recession does not come in the second or third quarter, upward pressure on intermediate- and long-term interest rates may abate, and Treasuries could rally. If the stock market does another swoon, a flight to safety would give additional buying support for higher-priced Treasuries. b. The case for selling Treasuries: The author discussed the potential for a bursting bubble for bonds in early January. Since then, there have been signs that the bubble might be deflating. The chart below of the ETF for long-term Treasuries, the iShares Barclay's 20-Plus-Year Treasury Bond ETF ( TLT) shows the dramatic move down over the past two months. The decline was especially steep from late April to early May. An attempt to rally in May appears to have failed.
ETFs for buying U.S. Treasuries include TLT, the iShares Barclay's 7-10 Year Treasury Bond Fund ( IEF) and the iShares Barclay's 1-3 Year Treasury Bond Fund ( SHY). There is one ETF for selling (shorting) Treasuries: the ProShares Ultrashort 20-Plus Year Treasury ( TBT). An investor has the choice of shorting one of the three long-position funds or buying the leveraged long-term bond short position fund. Reminder No 1: The three iShares funds pay dividends monthly, worth between 3% and 4% per annum. If you are short any of these, you will pay the dividend each month. Reminder No. 2: TBT has the same problem as many other funds, particularly leveraged funds, of accumulating daily tracking errors. Performance over many months can be much less than expected for perfect tracking. Here are some additional cautions to help you avoid jumping in front of a speeding train:
- Some of the ETFs mentioned in this article are leveraged. An investor should always study the prospectus carefully before investing. Tom Lydon has written about some of the things you should be aware of regarding leveraged ETFs. (In this article we mentioned the long-term tracking problem several times and gave one detailed example in idea No. 7, real estate.)
- Present prognostication is no guarantee of future results. Do your own due diligence. Study the images you see of speeding trains and then decide which are real trains and which are illusions.