Not Sure If The Bull-Run Is Fundamentals Driven? Here’s How You Can Hedge With ETFs

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The stock market is scaling newer heights every day, as economic data indicates a recovery that’s more sustainable and fundamentals driven. The core sectors of the economy have done well in 2012 and the momentum is gaining traction, if you believe the published numbers. However, though the domestic growth story gains credence, international events may turn the mood negative sooner than later.

Energy prices remain a key concern and may slow down growth if not checked. The Eurozone still provides many challenges, especially Greece, Portugal and Spain. Elections are due in April/May and Athens may spring a surprise following the voting. Spain is struggling with high unemployment rate and a spiraling budget deficit. True, the LTRO has given the peripheral states three years time to spruce up their balance-sheets; still they remain vulnerable to external shocks.

Fortunately, the ETF industry offers investors safety nets from downside risks. Sophisticated investors may choose to invest in derivatives to mitigate risks, while a great many opt for more traditional instruments like bonds and precious metals.

A raft of market neutral ETFs have unveiled by Boston-based issuer Quantshares and can help investors lower their portfolio volatility. The products are sector and market neutral and helps minimize losses by taking advantage of fluctuations. They hold dollar neutral, equal weighted long-short positions, making them effective in both bear and bull markets.

The U.S. Market Neutral Anti-Beta Fund (BTAL) is long on low-beta stocks and short on high-beta firms. Lower beta stocks tend to outperform more risky high-beta stocks when markets turn choppy.  This ETF can be ideal for investors who perceive greater volatility ahead, but are unwilling to take short positions on select stocks.

The U.S. Market Neutral Anti-Momentum Fund (NOMO) takes a little different approach. It is long on shares that exhibit low momentum characteristics while shorting high momentum stocks. Investors many a times experience momentum bias in their portfolios that can be eliminated through this product. The underlying securities in NOMO are rebalanced every month.

The U.S. Market Neutral Quality Fund (QLT) takes a more fundamental approach and buys a combination of both high ROE (return on equity) and low DE (debt-equity ratio) stocks, while shorting companies with low/negative ROE and high DE ratio. The philosophy is simple; firms with strong fundamentals outperform their weaker counterparts in volatile markets.

So, in theory these ETFs can make some sense for certain investors. However, if you look at the charts for each of the ETFs mentioned, you’ll notice a downtrend firmly in place. That simply means that you would have not participated in the current rally.

And therein lies the rub. You will miss out on clearly defined bullish periods in the market, while you may gain some downside protection when the bear strikes.

Of course, I am biased, but I believe that following trends in the market place via my Trend Tracking Indexes (TTIs) gives you the best of both worlds and, when used with my recommended sell stop discipline, lets you control downside risk more effectively, which in turn allows you to sleep better at night.

Disclosure: No holdings

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