Monetary inflation does not simply make prices rise for everyone. Price inflation is (all other things being equal) the societal recognition that monetary inflation has already taken place. The people who first got the new money were able to spend it before prices rose. Prices rose as people noticed that they were losing stock faster than before and raised prices to slow down the purchasing. (Would you rather have a store with empty shelves and only as much revenue as last month? Or would you like to get more money from the higher demand for your goods?)
So the rise in the prices is mainly a tax on those farther away from the new money. Those selling goods and services to the government will profit while janitors will see their standard of living slip lower.
How this money game works in the American bureausaur is not clear to me. But I’m beginning to wonder if it is connected to the stock market. To put it simply, if I want affordable gas and heating prices, then I want the DOW and Nasdaq to descend into the toilet. Immediately prices go down as well. And then I can afford to live.
So am I wrong? Is a rising DOW simply a measure of a successful predator class practicing “siphon up” economics?
I suspect that you are correct. Folks with knowledge and means can move money into and out of gold, overseas banks, or hedge against the market. Where I think you are wrong is that really smart people like Taleb also make massive money when the market tanks. I have been buying an ETF called VXX with my meager money. It basically moves inverse to the market based on panic. I believe Taleb made most of his money by betting massively against the market. The best the “little guy” usually does is have a 401k that he doesn’t know how to manipulate. And most of the advice out there is always “buy and hold.
I’d be careful with VXX. It has a number of problems including a common problem for futures ETFs/ETNs: negative roll yield when the benchmark (which, in this case, is VIX) goes into containgo. Notice this comparison here:
http://finance.yahoo.com/echarts?s=VXX+Interactive#chart3:symbol=vxx;range=6m;compare=^vix;indicator=volumema%2860%29+mfi;charttype=line;crosshair=on;ohlcvalues=0;logscale=on;source=undefined
Thus, the VXX is not a very good long term play. It has some short-term problems as well as can be seen here:
http://vixandmore.blogspot.com/2009/10/why-vxx-is-not-good-short-term-or-long.html
This is not to say that it should never be used but you definitely need to know what you’re doing with this one. I like the idea of shorting it after a good panic has set in but I haven’t tried it yet.
Mark, I don’t really understand the reasoning here. Over the long-term, stock indices track most directly with company productivity. Sure, there’s some inflation baked in but the DOW would hardly go into permanent decline if you stopped inflating. And the price of natural gas doesn’t correlate all that well with the DOW.
Derrick, there is also EEV and GLD!
Help me out, if I keep buying positions at 30 and it spikes to 120 during a panic, how am I losing out?
Some potentially useful tools there but know their limitations. EEV is a levered inverse ETF (leverage is 2x) and like all levered ETFs (as far as I know), it suffers from a mathematical problem. These funds are balanced every day in order to track the daily performance of their benchmarks. While the daily balancing accomplishes the stated goal of returning “twice the inverse of the daily performance of the index,” it creates a long term problem in volatile, erratic markets. Let’s say the index moves +4% and -2% over a two day span. So you have 1.0 * 1.04 * 0.98 = 1.019. So you’d expect the 2x inverse ETF to return 2 * -1.9% = -3.8%. Instead, you have 1.0 * 0.92 * 1.04 = 0.957… a -4.3% return. This is an additional loss of 0.5% in two days!
Now if the index is mostly going in one direction, the 2x ETF should get a benefit. But with markets bouncing around as they usually do, you usually end up with this:
http://finance.yahoo.com/echarts?s=EEM+Interactive#chart6:symbol=eem;range=2y;compare=eev;indicator=volume;charttype=line;crosshair=on;ohlcvalues=0;logscale=on;source=undefined
The beginning of this 2 year chart is mostly in one direction so the 2x ETF benefits by going up more than 2x the amount that the index falls. But things quickly go south as the markets start to gyrate and as EEM stabilizes, EEV takes a beating. In the end, EEM is down about 20% but instead of being up 40%, EEV is down huge. Choose the 3 month chart and EEM is down about 8% while EEV is up about 10% (instead of being up 16%). So levered ETFs are not long term plays and can be dicey in the medium term as well. Caveat emptor.
If VXX goes to 120, you’ll be mopping up. But notice the nasty roll yield that’s affected VXX lately. For VXX to get to 120 now, the VIX would have to go to Pluto which means that you’d better have a good supply of toilet paper, baked beans, and shotgun shells. A bank run may well be in order as Al Gore’s documentary hits the fan. Ahem. But seriously, VXX can work in the short/medium term but beware of the forbidden dance of the containgo. Since July 09, it has pounded VXX.
I’m banking on panic due to the debt crisis or some other Black Swan.
Thanks BTW.
I don’t understand how this works, but I have a question: Derrick, is it really a simple reverse-the-percentage as you suggest and not a multiplicative inverse? The way you frame it, it sounds like if the index went up 50% in one day then the 2x ETF would go straight to zero, but that doesn’t seem right at all. If I assume it’s a multiplicative inverse instead then the numbers are actually favorable in your particular example. Well, favorable since it was a loss. Maybe a -4%/+2% would be a better example since it makes clear that not only the loss but also the gain is dampened by the daily reckoning?
I know next to nothing about all this, and am honestly curious. Although realistically I’m not sure it’s worth my going very deep, especially not really having the means to play.
Yeah, leverage can hurt, shorting can hurt, and shorting on leverage can really hurt. Let’s say I short a stock at 50 with no leverage. I therefore cough up 50 points of equity for the trade. Now let’s say the stock increases 50% to 75. I lose that 25 point delta so that I have 25 points remaining. I’ve lost 50%. Since there’s no daily rebalancing here, this move could happen in a day or a year and my loss would be the same. But if that short position that I took was leveraged 2-1, it means I only have 25 points of equity for a trade at 50. If the stock falls to 40 and I buy it back, the stock has lost 20% (-10/50) while I’ve gained a 40% (+10/25) return on equity. But if the stock goes to 75, I lose 25 points which means that I do indeed lose all of my equity (-25/25 = -100%). So a stock move of +50% means I have a -100% move. At this point, my broker may either automatically eject me from the trade or ask me to pony up some more cash (a margin call) to cover possible additional losses. If I stay in the trade and the stock goes up another 25 points to 100, I’ve lost another 100% and probably some dignity as well.
So yes, if the index for a 2x inverse ETF goes up 50% in one day, then in theory at least, the ETF should lose all its equity. I’m not sure if something like this has ever happened or what the ETF managers would do about it. I suppose they may have something like automatic “circuit breakers” in place so that after a certain % loss during a single day, they take some emergency action. But I’m just guessing.
This is why if you want to short equities, brokers will require you to add the capability of margin trading to your account. They treat shorting like they treat margin (i.e., leveraged) trading. If you go long a stock with no leverage, you can never lose more than your initial investment. But if you go short (even without leverage), then like margin trading, you can lose much more than your initial investment. If you go short with leverage, the return on equity could get ugly in a hurry if the trade goes against you.
Interesting tidbit: Right now, I believe the highest leverage (by law) that individual investors can employ in overnight equity accounts is 2-1 (4-1 for day trading accounts). Leveraged ETFs basically exist in order to get around that law and trade at higher margins. So if my account has a max. margin of 2-1 and I put all of my money in an ETF that is also levered 2-1, my trade is levered 4-1. So these levered ETFs were created by and for professional (day) traders to get around the legal margin limit. Peons like me can use them but we need to know what we’re getting into.
Derrick, thanks. That clears up my confusion!
No problemo.