ETF Update: The Fear Trade

One of the strongest features of a trading system is that it forces the user to look beyond the human interpretation of data.  Evaluating systems can be done through appropriately designed tests.  Evaluating human management is nearly impossible.  There is never enough data, and circumstances change.  Even Warren Buffett is now drawing criticism.

A system forces one to re-examine fundamental principles, looking for possible exceptions.

Let us suppose for a moment that there is a divergence between our expectations - for the economy, for profits, and for stocks - and the general market perception.  With a long enough time horizon, an investor can, and perhaps should, act upon those expectations.  Even so, it would be even better to time entry points to coincide with the changing market.

Our trading method, looking at Trends, Cycles, and including a bit of Anticipation, considers which ETF’s are the most promising for the next month or so.  Putting this all together, we call it the TCA-ETF system.

It is quite satisfying when the system supports our personal view of the world.  It is just as important when it does not.

During the last week, our indicators shifted dramatically, recognizing “The Fear Trade.”

Elements of the Fear Trade

The fear trade includes selling stocks, especially financials, buying gold (whether metal or miners), and buying US Treasuries.  The argument for the fear trade can be readily found via a Google search, so we are not going to provide any links.  Many purveyors of fear are also sellers of expensive gold coins or metal.  Some also sell high-commission annuity products featuring downside protection and severely capped upside gains.  You can actually play it without getting ripped off.

The savvy investor needs to understand the fear trade, both when traders are putting it on and also when it is time to unwind.  In the last week, the TCA-ETF model picked up these signals, making an abrupt shift at mid-week.  This led us to sell long sectors and pick up the inverse ETF’s, while maintaining our position in gold stocks.

We own gold stocks via the Van Eck Gold Miners ETF (GDX).  In an earlier look at GDX we explained the characteristics of this holding, and also our preference for holding stocks rather than the metal itself.

While we are short-term investors in the fear trade, this is a treacherous week for that position.  The Obama administration has a salvo of policy announcements and appearances.  We expect much of this to make sense, but the market remains very skeptical.

Other Viewpoints

Here is the basic fear trade viewpoint from the WSJ:

Not to be ignored for banking stocks was the continued crowd into a “fear trade.” Gold prices hit $1,000 an ounce early in the session, while Treasury securities gained throughout the day’s trade.

For equities, the fear trade isn’t just to sell stocks but to bet on a decline. Notably, puts, or the right to sell banking stocks, have ratcheted up for the better part of a month. Moreover, short-interest levels for banking stocks such as Citigroup (C), Bank of America (BAC) and even General Electric (GE) have moved higher in the past two weeks.

“It’s basically impossibly hard to call a bottom for bank stocks,” said Craig Peckham, equity trading strategist with Jefferies. “And with the inability of the marketplace to pinpoint any base value for banks, the loss story and capital-erosion picture continues to drive shorts.”

You can get the same viewpoint from CNBC on nearly any of their shows.  It is normal for guests to make comments that seem wise in the context of current action.  My Street.Com colleague Doug Kass noted one day last week that seventeen out of eighteen guests were bearish.  Wow!

Jon C. Ogg at 24/7 Wall St. does a nice job with the underlying fear.  He also notes that our own choice, GDX, has so far lagged the move in the metal. That is good for our position.

David Fry does his regular technical analysis, and sees “added stock market risk” in GDX.

There are also some who believe that the massive government actions will have impact.  At The Trading Goddess, the article Print, Baby, Print, does a nice job of looking ahead to reflationary (and inflationary) effects of current policy.  Readers should click through to see the (ahem) fully-illustrated description.

Weekly TCA-ETF Rankings

There was significant turnover in our rankings and holdings.  Two of our three inverse ETFs moved into the buy zone, helping us to hedge our positions late in the week.  For investors in our weekly program, we always look for these late-week signals.

Because of the current ratings, we are shifting to a bearish stance in the Ticker Sense Blogger Sentiment poll. There are only eight of 57 sectors in the “buy” range, and two of these are the inverse ETFs.  We note that the model has correctly evaluated the Q’s as stronger than SPY (SPY) or DIA (DIA).

While this is our official stance, we are watching carefully, since there will be plenty of news on the Obama plans.  We would not be surprised to see another mid-week shift, and we might even anticipate in discretionary accounts.

Listed below are this week’s rankings.

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