Five ETFs For A Double Dip Recession

by on November 9, 2009 | ETFs Mentioned:

March 9 may very well go on to become a day that lives in infamy, the point at which the U.S. stock markets bottomed out and the economy turned the corner. To this point, it looks to be the point at which investors finally put the worst recession in a generation behind them and a recovery began. But despite the recent rally, many analysts believe that the current recovery lacks support from fundamentals, pointing to historically high pricing multiples, still rising unemployment rates, dips in consumer confidence, and stimulus programs that have encouraged further indebtedness for many Americans as evidence that we’re not out of the woods yet.

The Bears and Bulls Are Duking It Out On Wall StreetAnd it’s not only the well-known bears spreading doom and gloom this time around. Jeremy Grantham sees a market that is 25% overvalued, while others see a correction of 40% coming. Analysts at Morgan Stanley recently expressed their belief that asset prices have been boosted by access to “easy money,” and that the current stock market bubble will soon pop. There have been a number of terms coined to describe a potential slip-up in the fragile recovery that is now underway: the more optimistic among us are predicting a “V-shaped” recovery, while those who believe the recent rally in equity markets is unwarranted predict a “W-shaped” or “double dip” recession.

If we do indeed see a double dip recession, investors would be well served to have some amount of “portfolio insurance” to prevent a significant decline in the value of their holdings. Below is a look at five ETFs that could perform well relative to the broad markets if the numerous bears are proven right (for more actionable ETF plays, sign up for our free ETF newsletter or a free trial to ETFdb Pro):

  • iPath S&P 500 VIX Short-Term Futures ETN (VXX): Over the last two years, investors have lamented the fact that diversification across sectors and geographies has let them down just when they needed it most. An investment in futures on the CBOE Volatility Index (better known as the VIX) has done the exact opposite. Since September 2007, the correlation between the VIX Index and the S&P 500 SPDR (SPY) has been -0.72 (its important to note that VXX doesn’t track the VIX directly, but rather a basket of near-term futures on the index). If a double dip is ahead, it is likely that it will be accompanied by significant volatility, which could translate to strong performance from VXX.

VXX

  • SPDR Gold Trust (GLD): Gold has been one one of the most effective safe haven investments historically, and GLD, with a market capitalization of more than $20 billion, has become one of the most popular ways for investors to gain exposure to bullion. As concerns about the sustainability of the recovery have mounted in recent weeks, gold prices have surged to more than $1,100 per ounce. If a double dip begins, investors can be expected to quickly lose their appetite for risky assets and flock towards reliable stores of value. For a complete look at ETF plays offering various degrees of exposure to gold, see this guide.
  • MacroShares Major Metro Housing Down (DMM): This exchange-traded product is one half of the paired funds from MacroShares offering exposure to single family home prices in the U.S. The two funds are bound to pledge assets to each other based on the value of the S&P/Case-Shiller Home Prices Index. The MacroShares Major Metro Housing Up (UMM) has been gaining in recent months as optimism about a stabilization in residential real estate prices has set in, but a double dip recession would likely reverse this trend.

DMM

    Period Correlation
    Daily -0.928
    Weekly -0.928
    Monthly -0.919
  • ProShares Short S&P 500 (SH): Taking a short position in the stock market over the long term is generally a poor investment strategy, but doing so through an inverse ETF over the short to intermediate term can be an effective way to profit from a downward correction (see this guide to inverse ETFs for a more thorough discussion of how to use these products). As most investors know by now, inverse ETFs operate on a daily basis, meaning that holding them for multiple trading sessions carries certain risks. But SH doesn’t utilize leverage to achieve its results, so its performance over longer periods of time tend to more closely resemble the inverse of the underlying index. Since its inception in June 2006, SH has been very efficient at delivering returns equal to the inverse of the S&P 500 on a daily, weekly, and monthly basis.

SH Has Mirrored The Returns of The S&P 500 Over The Last Three Years

  • Claymore / Sabrient Defensive Equity Index ETF (DEF): For investors hesitant to significantly reduce their equity exposure for fear of missing out on an extended rally, DEF may be an interesting option. This ETF invests in the stocks of companies that reflect low relative valuations, consistent dividend payments, and a history of outperformance during bearish market periods. As of September 30, DEF had allocations to the utilities and consumer staples sectors of about 25% and 17%, respectively.

DEF

Disclosure: No positions at time of writing.