Please comment on Investing in Bleak Times from The Australian12.10.2011

Bear traders can't wait for bulls to take a dive
    by: Richard Hemming
    From: The Australian
    October 12, 2011 12:00AM

WHEN London-based financial trader Alessio Rastani recently said on the BBC that Goldman Sachs ruled the world and that he went to bed each night dreaming there would be another deep recession where millions were jobless and economic growth stagnated, it got some brain cells moving.

Leaving aside the moral issues (which Rastani says don't exist for traders), can you really profit from other people's misfortune?

Several top-performing traders make it clear that you can.

But their solutions vary widely and include everything from shorting (or selling without first owning the underlying asset) various index futures, such as share price index futures on the Australian Securities Exchange, or on the FTSE; to buying other exotic instruments such as the VIX, an index measuring the volatility of share prices in the US; or even purchasing credit default swaps, one of the supposed culprits for the financial crisis that are still fresh in people's memories.

Others point to various exchange traded funds that allow you to bet on others' misery; some continue to advocate buying gold despite its recent weakness; while a few say you should wade into the stockmarket.

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In a nearly mirror image of how ethical funds tend to view the world, stocks that may do well in tough times include poker-machine makers, fast-food makers, tobacco producers, debt collectors, "micro-finance" providers, or pay-day lenders and pawn shops, as well as less controversial utilities such as toll roads and supermarkets.

Whatever definition of recession you choose, all agree there is an abundance of bad news priced in to any market you care to name, the main ones being equities, debt and property.

Regardless of what the real economy is doing, or not, securities across the world have fallen dramatically.

In the six months to early this month, Britain's FTSE Index has fallen 18 per cent, in the US the S&P 500 Index has dropped 15 per cent, while domestically the All Ordinaries Index has dropped a whopping 22 per cent.

Money is being poured into what many consider the ultimate shelter from financial disaster, US Treasuries. The return from these is negligible, hardly providing the kind of return that would make Rastani a fortune. For example, US 10-year government bonds are trading below 2 per cent.

Despite these falls, there is no doubt that more weakness could follow, and sooner than you think.

At just below 4000 points, the All Ordinaries is still more than 30 per cent higher, or about 900 points above where it was in early March 2009.

Todd Gilmore has been a trader for Citigroup and ABN Amro, and trades successfully on his own.

He says shorting in bear markets is very dangerous because of the propensity for short sharp rises.

"If you shorted the Nikkei stocks prior to the Asian crisis in the late 90s you would be broke because of the monster run," he says.

Which is nearly what happened to Sydney stockbroker Rene Rivkin, by the way.

In just one recent day's trading, after being down for most of the session, the US S&P 500 Index rallied 45 points in the last hour of trade to close up 25 points, while the Dow Jones rallied just shy of 400 points, or about 4 per cent in the same period.

"This kind of activity highlights that it's a bear market, where there are sharp bounce backs on thin volumes," Gilmore says.

Timing is everything in order to make money in any market but it is particularly hard to pick the direction in the absence of concerted volume.

Says Gilmore: "There is more negativity to come. What you have to wait for is when the serious money comes in, and that's when you'll see some big falls. The true direction emerges when volume trades and that happens when there are big margin calls."

Often the big money in bear markets is made when an investor sees such falls on volume and is prepared to stick their neck out and buy up big. A classic case of this is arguably the most famous investor, Warren Buffett and his Berkshire Hathaway group. Buffett's big bets have involved famous bailouts of Goldman Sachs and General Electric during the height of the financial crisis; and more recently investing $US5 billion ($5.3bn) in Bank of America.

"It's the guys like Buffett who sell when the man on the bus gives them advice, and who step up and buy when everything looks to be going to the dogs" Gilmore says.

But for the canny investor there is often money to be made from trading volatility measures, such as the VIX, which is traded on the Chicago Board of Options Exchange, and ETFs, according to derivatives expert John Lyons. "You have to get your view right no matter what you do," he says. "But

if you think there's an Armageddon coming, then has the volatility topped out, no? The VIX hasn't got back to 2008 levels."

The VIX, which incidentally can be played by Australian investors via a futures broker, has more than doubled in the past three months and stands at 40 points. At the height of the financial crisis in early 2009 it climbed as high as 80 points.

Lyons has worked as a strategist for various hedge funds and lectures on exotic derivatives for the Australian Financial Markets Association, which represents the country's big financial institutions.

He says ETFs could be easier for investors to trade and may not exactly track the VIX.

The website www.etfdb.com has a list of ETFs that can give the punter exposure to volatility as an asset class, as well as exposure to short positions in certain markets.

For example, if the S&P 500 Index heads further south, there is an ETF you can buy, called inverse equities, that will go up.

As Rastani no doubt says to himself, what more could a pessimist hope for?

About the Author

Caroline Mark

Caroline is the publisher of Under the Radar Report. She has a diverse background, from producing financial publications, to fundraising and marketing.

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