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Leveraged ETF’s, despite their significant risks (counterparty risk correlation risk to name a few), are gaining in popularity.  There are several institutions offering double exposure ETF’s, and now a new entrant is even offering TRIPLE EXPOSURE ETF’s.  Here is a sampling of the leveraged lineup:

• Proshares - offers single and double exposure index, sector and international ETF’s.  Also offers inversed double exposure ETF’s.
• Rydex - similar offering to that of proshares, with 14 double exposure ETF’s.
• Powershares -In general, their ETF’s hold fewer positions than traditional ETF’s, but they are not leveraged as of yet.  But I do like their dollar bull ETF (symbol UUP).
• Horizon Betapro ETF’s - Offers HBP Bull+ ETFs for double the daily performance of their underlying equity index or commodity, and HBP Bear+ ETFs for double the daily performance opposite that of the underlying index or commodity.
• Currencyshares - Not quite a leveraged lineup, but certainly worth mentioning.  These ETF’s offer a convenient way to bet on foreign currencies.  Personally, I’m more of a dollar bull then ever, but I do like the Japanese yen strength these days.  The symbol is FXY, but buy it at your own risk!
• Direxion Funds - Currently offers 1.25x and 2.5x leveraged ETF’s.
• Direxion Shares - In an industry first, they will soon offer triple leveraged (300%) ETF’s.  There will be 16 available, including the Large Cap Bull 3X (BGU), Small Cap Bull 3X (TNA), Large Cap Bear 3X (BGZ) and the Small Cap Bear 3X (TZA).

The most interesting fromt he list above are the new 3X leveraged ETF’s.  From the prospectus, there are numerous risks associated with these ETF’s.  The ones that stand out to me are:

• Correlation risk - In a nutshell, it’s virtually impossible to achieve exactly 3X the performance of the index, so don’t be surprised if the underlying goes up 1% and the 3X ETF only goes up 2.5%, and vice versa.
• Counterparty risk - Direxion uses counterparties that have access to financial instruments used to target those 300% returns.  There is no guarantee that those counterparties are, or will remain solvent in the future.  (Hint:  Bear Sterns, Lehman Brothers)  From the prospectus, “The Funds will not enter into any agreement involving a counterparty unless the Adviser believes that the other party to the transaction is creditworthy“.
• Credit risk - From the propsectus, “A Fund could lose money if the issuer of a debt security is
  unable to meet its financial obligations or goes bankrupt”.

More on correlation risk - In general, the leveraged ETF issuers do not disclose their methods for achieving 2X or greater leverage.  With the 2X funds, my own speculation tells me that the counterparties involved are either double short or double long the underlying.  The counterparties pay significant margin interest which is then passed on to the issuing fund (proshares or rydex for example), and eventually to the investors.  But with 3X funds, it’s more likely they need to access the futures and options markets to achieve the triple leverage.   If so, that could significantly increase the correlation risk for the following factors:

• Time decay - Options and futures have time premiums and time decay, which could cause more correlation differences in the 3X funds.
• Spread risk - The BID/ASK spreads on options and futures is increasing with the increasing volatility of the markets.  The institutions certainly would get the best prices, but the spreads are still not free, and the options/futures spreads are certainly larger than the spreads on stocks and ETF’s.
• Liquidity of options and futures market - It’s great for amateur investors, but if these 3X funds take off, they could find it difficult to roll contracts due to the volume involved.

Also check out:

• Correlation Error With Leveraged ETF’s

Here is a hilarious parody of Der Untergang (The Downfall), a classic movie that depicts the Nazi dictator’s final days in his Berlin bunker at the end of WWII.  The audio is legitimate, but the subtitles have been overwritten with parodied accounts of foreclosure, financial crisis.  Hilarious!

Mr. Mortgage just wrote up a great summary of the soon to be released pending legislation on the free mortgage bill.   The good news is that government “leaders” are finally realizing that the housing “boom” of the last 8 years was fake.  Part of the massive bailout program occuring now is a mandate to dig deeper into the ridiculous housing loans made during the last 8 years, and assess the magnitude of insanity.  The bad news is that it ain’t pretty!

They now realize that the entire housing “boom” was aritificial and brought upon by mortgage loan programs and leverage that were only available for a brief period of time and that will never exist again. Most of the loan programs contained fraud because the way the programs were structered. Ultimate affordibility through creative financing made it so everyone in the nation earned $150k a year and housing prices reacted accordingly.  Unsuspecting buyers who really earned $150k bought homes under fraudulent conditions and are now 50% underwater in their homes. They will be asking for a bailout as well.

And now the really bad news.  Initial attempts to restructure failing mortgages are failing.  New lending standards require that people have actual jobs with real and verifiable income in order to refinance, and can no longer count the anticipated appreciation in their homes as “income” as they once so commonly did.  (DUH!!)

Many banks are all of a sudden coming out with pre-emptive loan modification plans.  This is because they have finally realized that everything the housing market was built upon in the past six years was fake.   Wachovia was one of the first.  But from early reports I am getting the program is failing miserably. Apparently Wachovia’s close ratio is less than 10%.  This is because they did not estimate how many ‘liar loans’ were really out there or how far housing values have fallen.

And now the really really really bad news.  There are massive lobbying efforts going on now to create an unprecedented homeowner bailout, including the possibility of fully subsidizing mortgage payments for three years.

The Next Bubble - If such a program is passed, it will encourage ALL borrowers to stop all mortgage payments, because there would no longer be risk of default.  What do you get when millions of financially strapped borrowers no longer need to make their $2000-$5000 mortgage payments?  Answer - Wind fall free cash flow to buy new televisions, cars, vacations and more.  Just when you thought the debt ridden consumer was finally dead, trillions of dollars will soon be pumped into irresponsible borrowers hands with the explicit instructions to SPEND, SPEND, SPEND!

What Happens After Three Years - Hint.  It’s not going to be pretty.  If you thought the 2008 financial crisis was fun to watch, stay tuned for the next version - the 2011 Financial Crisis!

I just bought shares in the Market Vectors double short Euro ETN (symbol DRR).  ETN stands for exchange traded notes, which according to the website are “senior, unsecured debt securities issued by Morgan Stanley that deliver exposure to the exchange rate of foreign currencies.”  I have been a believer in a strong dollar recovery for quite some time, and the DRR is another instrument available to capitalize on it.   It is relatively new, with its inception date earlier this year on May 6, 2008.  I wrote about other ways to play the dollar recovery several months ago:

• Preparing for and playing the dollar recovery - bye bye euro

In that article, I mentioned several justifying factors for a strong dollar recovery, and those factors have led to a significant dollar bull market since that time.  I also mentioned a few ways to play the dollar recovery.  The Market Vector’s double short euro ETN (DRR) is a recent discovery.

Over the last few years, the dollar has been absolutely hammered for justifiable reasons - huge trade and budget deficits, plus lack of leadership to present a plan to rectify the imbalance.  But despite the fiscal recklessness within the United States, it is important to note that currencies only trade in relation to other currencies.  It was easy for traders to ignore problems in the rest of the world and focus on the weaknesses in America.  But the dirty laundry has come home to roost in Euro-land, and traders around the world are finally waking up to smell it, and punish the euro accordingly.  Among the european zone problems:

• Rising unemployment
• Falling manufacturing growth
• Tumbling real estate markets (Despite common belief, reckless lending did occur in Europe too!)
• Europe aggressively cutting interest rates
• European bank failures and bailouts
• Debt to GDP ratios that make America look responsible - From Nationmaster, the United Kingdom debt per GDP ratio is a staggering 387%.  France has a ratio of 173%, Germany 144%, Greece 148%, Ireland 758%, Italy 117%, and Finland 135%.

There are certainly more direct ways to play the currency markets on the Forex, but I do prefer the convenience of doing so with ETF’s or ETN’s.  But I also recognize that there is more risk in trading currency ETF’s and ETN’s as compared to trading directly on the Forex.  The DRR fact sheet lists out several of the risks associated with the double short euro ETN, including:

• Leverage risk - double exposure magnifies losses as well as gains
• Currency risk
• Non-diversification risk - susceptible to single market events
• Tracking risk - high volatility and effects of interest rates in the U.S. and Europe
  may cause Index return to deviate from a 2X leveraged short exposure to the spot exchange rate
• Issuer default risk - not secured debt; subject to credit risk

The last one is the one that shines out most, and is also the reason that I’m very careful with these ETN’s.  Just two years ago, it was simply inconceivable to most people that Lehman, Bear Sterns, AIG, Morgan Stanley, Goldman Sachs or other big name financial firms would face risk of collapse.  Morgan Stanley has escaped collapse thus far in the financial crisis, but they are certainly not in the clear as far as I’m concerned.   If Morgan Stanley goes under, there is a strong possibility that shareholders in DRR could be wiped out, regardless of the direction of the euro.  If you can’t handle that possibility, then stay away from these derivative currency plays.

Disclaimer: Trade at your own risk.  Nothing in this post, or anything at Geldpress shall be considered investment advice.

Barron’s just published an excellent article on convertibles, those mysterious investment vehicles often shunned by individuals and rarely understood even by “professionals”.  According to the article, convertibles have fallen 36% so far this year.

Converts have been hit hard for three main reasons: The stock market is down, the corporate bond market has been whacked, and hedge funds, once the dominant investors in convertibles, have been forced sellers after terrible performance this year.

Convertibles can be either preferred stock or bonds, which are often high yield.  Preferred shares ranks higher then common shares in the event of a bankruptcy, but carries no voting rights that the common shares do.  Preferred shares may also offer preferred dividends which are in line ahead of common share dividends for payment.

The Barrons article mentions three companies that offer convertible funds - Fidelity, Vanguard and Putnam.  I’ve listed three of the funds to start your own research, if you buy into the potential recovery of convertible funds that Barron’s does.

• Fidelity Convertible Securities Fund (FCVSX)
• Vanguard Convertible Securities Fund (VCVSX)
• Putnam Convertible Income Growth Fund (Class A Shares:  PCONX, Class B Shares:  PCNBX)

I wrote about some of the great stock screening tools in previous posts, but those free tools seem to get better all the time.  If you are looking for some great screening tools, start off with the following:

• Easy stock picks using free screening tools
• The best free technical stock screen from etrade
• Free technical analysis stock screens

In today’s volatile environment, I look for medium sized companies with solid earnings and a decent dividend.  Here is the criteria I used just today, as shown from the google finance stock screener. The criteria I use in today’s market is going to be very similar to the above.  For a medium sized company, I’ll search for market caps between 1 and 50 billion.  I don’t like to buy companies that are losing money, so I search for positive price to earnings ratios between 5 and 15.  Dividends are king so I make sure to look for ones that are paying something back to me as an investor, and a dividend yield between 3% and 5% should do the trick.  And to top it off, I like to screen for the 52 week price change.  I like beaten down stocks, but not ones such as financial institutions that have lost 90% of their value and losing money hand over fist.  I set the threshold at negative 40% on the low side.  And on the high side, I prefer to stay away from bubble territory, so a positive 20% is good enough on the high side for 52 week change. For diversification, you can also limit the results for a particular sector or exchange.  It’s best to take a look at your own portfolio distribution.  If you are currently heavy in energy, you can limit the google screen to healthcare, conglomerates or another sector that balances your portfolio out a little more. The screen above returned 65 matches that you can do additional research on to find something to buy.  Some of the additional things I like to do are the following:

• Screen out anything based on personal biases or current portfolio weightings - If you only want American companies, you can rule out Honda Motors.  If you are fearful of anything related to the auto industry, you can rule out Genuine Parts.  You can also eliminate ETF’s which sometimes come up in the results.  The particular results above returned several iShares ETF’s.
• Limit the search to specific sectors as a tool to diversify your own portfolio - Use the drop down sector box to pick a specific industry you feel you need to buy in order to balance out your own portfolio.
• Take a look at the google finance Income Statement (example income statement here).  I personally look at the Net Income in the middle of the page and the Diluted Normalized EPS.  I like to see positive and somewhat stable numbers for the last 5 quarters.  Currently, google only has quarterly data available going back 5 quarters, but you can also look at the yearly data to go back a few years without the quarterly breakdowns.
• Take a look at the google finance Balance Sheet (example balance sheet here).  I personally like cash rich companies so I look at the Cash and Equivalents at the top of the page.  This is especially important in today’s very tight credit markets.  I also look at the Total Debt numbers in the middle of the page.  Is it a manageable number as compared to their existing Free Cash Flow?  Is their total debt increasing, decreasing, or stable?
• Take a look at the google finance Cash FLow Statement (example cash flow statement here).  I look to the Net Change in Cash near the bottom of the statement.  I like to see positive numbers for all viewable quarters and annual periods available.  I won’t necessarily rule out a company with an occasional negative cash flow, but I may have to dig deeper to justify the negative cash flow.  I also like to compare the annual positive cash flow in relation to the long term debt.  A good rule of thumb is the number 3.  If a company is capable of paying off their entire long term debt with 3 years of positive cash flow, then their debt levels are manageable.  Note, I’m not implying that a company needs to pay off their long term debt, only that they are capable of doing so.
• Optional - If you have any faith in efficient market theory, you can stop here and pick one of the results that matched your additional and manual screens.  The other approach is to analyze yourself into a corner by digging deeper into the quarterly and annual reports, listening to the conference calls, and reading research reports, and blog and message board reviews.  But it’s virtually guaranteed you will stumble into something you don’t like - pending lawsuits, consistent “one time” charges, underfunded pension liabilities, higher input costs, labor disputes and more.

The next question - to hedge or not to hedge? Once you find something you are willing to throw your money at, the next question to ask yourself is whether you want to hedge your bets.  The idea of hedging is that no matter how much research you do, you can still be wrong, and still lose money.  Hedging offers you a way to limit your downside risk in exchange for capping some of your upside risk.  Here are some other articles that discuss hedging, and a book recommendation on PUT Options (one of the most common hedging techniques).

Note:  While it’s great to have the free information in the articles at Geldpress, sometimes it really does help to buy a good book to get the entire picture.

• Trading strategy - hidden jewel in the shorts
• Portfolio protection - hedging todays roller coaster market ride
• Selling puts for income, or as a cheaper investment
• Time for cover - the covered call

Put Options : How to Use This Powerful Financial Tool for Profit & Protection by Jeffrey M. Cohen

Art Laffer just released a new book entitled The end of prosperity:

The End of Prosperity: How Higher Taxes Will Doom the Economy–If We Let It Happen by Arthur B. Laffer

The New York Times just gave him free publicity by allowing him to write his own pump piece about the book.  In the article, Mr. Laffer criticizes the administration on their $700 billion bailout and socialization of banks.  He calls for a market driven correction instead of government interference.  He cites several economic statistics in the article and in the book, but unfortunately, most of them are wrong.  In what seems to be intentional humor, he praises former president Clinton for “strengthening what had begun under President Reagan”.  Art Laffer was Reagan’s former economic adviser; many people now believe that Reagan was already undergoing severe head trauma caused by Alzheimer’s when he made that idiotic selection.

For additional information on Art Laffer, refer to:

• Peter Schiff schools Reagan economic adviser

Needless to say, this is one book I do NOT intend to buy.

The number one issue facing America today is the economy.  We need a new leader that will work to steer our ecomony in the right direction, enforce fiscal discipline, and work to resolve the underlying problems that caused the chaos in the financial sector.  Sure, there are other issues - position on abortion, civil rights, immigration, health care, Iraq, privacy, taxes, education, etc.  But they all stand a distant second to the number one issue on the economy.  If we do not fix our economy, then you can forget about every other issue on the table, because there will be no money left.

2008 has proven a very difficult year for endorsing a presidential candidate.  On the republican side, you have John McCain, the very kind hearted, but unfortunately economically illiterate man, and Sarah Palin, the housewife from Alaska that just spent $159,000 in campaign money on her new sexy wardrobe.  And what about Sarah Palin’s position on the economy and the $700 billion wall street bailout?  In the video below, she mentions that she is still unsure about her position.

On the democratic side, you have Obama and Biden, magnitudes more intelligent then either McCain or Palin, and without a doubt more fit to lead this country then their republican contenders.  They are both top notch public speakers and leadership comes natural to both of them.  They answer rapid fire and often difficult questions from the media directly and without hesitation.  That is exactly the kind of public speaking we need in front of the international media to help stem the influx of criticism still reigning from two Bush terms.  What are Obama’s view on the bailout?  Watch this short video of him responding to Paulson’s initial 3 page $700 billion bailout bill.  His thoughts are well organized and clearly communicated.

What about the third party candidates? - I’m as sickened as anyone that 3rd party candidates are intentionally ignored from the media and not invited to national debates.  But that should not stop us from researching those candidates on our own.  Bobb Barr and Wayne Root are the libertarian candidats running for office.  There is an interesting video of Bobb Barr on youtube, where he refers to 10 year old warnings on the coming financial crisis.  But similar to McCain, I question the logic of Bobb Barr’s choice of running mate, a sports handicapper, and Vegas gambler:

The King of Vegas’ Guide to Gambling: How to Win Big at POKER, Casino Gambling & Life!The Zen of Gambling updated by Wayne Allyn Root

Ralph Nader and Matt Gonzalez are also running as part of the the consumer advocate party.  I commend Nader’s hard line view on the bailout, and his pursuit of fiscal discipline.  But his public speaking skills are lacking, and both him and Gonzalez lack the experience to run this great country.   As for the other third party candidates, you can see the entire list here.

What about the Obama endorsement? - In the words of John McCain himself, Barack Obama is a “decent person and a person that you do not have to be scared of as president of the United States.”  I completely agree with McCain, but that does not mean I’m completely encouraged by the thought of an Obama presidency.  There is one sticking point that I can not get beyond with Obama, and that is his call for a foreclosure moratorium.  This is where Obama and I have fundamental differences.  Obama wants to use taxpayer money to pay down the principal of overpriced American homes.  I want those homes to be foreclosed and I want the market to reset their prices to reasonable and affordable levels.  Obama does not want to see former “homeowners” living on the street.  I want those “homeowners” living in apartments.  I think of that family of 4 struggling to buy food because of the burden of their $4,000 mortgage payment.  I want that family to realize the gain of $2,000-$3,000 in additional monthly cash flow when they save that much money by living in an apartment.

The Obama endorsement (barely) - Geldpress endorses Barack Obama and Joe Biden as the democratic ticket of choice in the 2008 presidential election.  We do so freely and not from bribes, torture or threats.  The choices were limited.  We searched long and hard for viable third party candidates but could not find one.  In the end, we came back to the two party system and started the elimination round.  McCain and Palin were the first to be eliminated, leaving Obama and Biden as our endorsed candidates (barely) for president and vice-president of the United States.

God bless America!  (We need it)

If you think there is volatility in the U.S. markets, you should look at Iceland.  The country closed its stock market entirely on October 9th due to “unusual market conditions”.  When they re-opened a few days later on October 14th, the market crashed 76% in a single day.  Those frequent 5% up and down days in the U.S. market seem pretty lame in comparison to Iceland.

In the currency markets, Iceland is also struggling, with their krona down over 50% this year, most of the losses having occured in the last few weeks.  And if that were not enough, the country just raised their key interest rate a whopping 6 percentage points to 18%.  This came as quite a surprise for a country that had just lowered their rates from 15.5% down to 12% two weeks ago.

The high interest rates of Iceland were once the appeal to Everbank foreign currency certificate of deposit buyers, who targeted high overseas rates to invest their money in.   A note on the Everbank Iceland CD page now states:

We do not currently offer any product denominated in Iceland krona.   Due to the Icelandic banking crisis, currency trading of the krona has been frozen.  This effectively locks Everbank out of this market and prevents us from offering this currency going forward.  If you currently hold a certificate of deposit in the Icelandic krona with Everbank  please know that we are making every effort to receive payments in U.S. dollars upon maturity of your account.

So much for chasing the yields on foreign currency certificates… For those still in denial on the potential for other seemingly stable countries to collapse, you will be happy to know that Everbank may still offer certificates of deposits in the Mexican peso, the Czech koruna, the Indian rupee, the Danish krone, the Brazilian real, the South African rand, the Swedish krona and many others.  I’ll pass on those offers with my own personal money, however, and invest in the good old greenback from the U.S.A.

This youtube video is one of the most important videos you can watch prior to making your vote heard in the 2008 presidential election.  Many people in government and on the streets will tell you that the financial crisis we are facing today was unavoidable and that nobody could have predicted it. But in reality, the 2008 financial crisis has been discussed at length for at least the last 10 years.  There were countless economists, savvy investors, book authors and blog writers warning of such a collapse to our financial system.  The only issue is that 90% of our government chose to ignore the warnings because they were to busy cheerleading for the phony debt based economy.

We need smarter people in government and advisers just won’t cut it in today’s economy.  I have heard some people defend McCain’s economic illiteracy because he will probably “choose a good economic adviser”.  Now that the 2008 financial crisis is in full swing, those people really need to watch this video of former economic adviser Arthur Laffer being schooled by Peter Schiff.

Don’t wait and hope to determine who the next president chooses as their economic adviser.  Instead, vote for the more intelligent presidential candidate, and preferably a well researched candidate amongst ALL of the choices, not just Republican and Democrat.  We can’t afford 4 more years of economic illiteracy in the White House and congress.  Please vote responsibly!

If you liked the video above, you will also like the following book by Peter Schiff:

Crash Proof: How to Profit From the Coming Economic Collapse (Lynn Sonberg Books) by Peter D. Schiff