I take this to mean that it’s premature to label the current fiscal crisis in Greece as a tragedy, as many commentators nevertheless are already doing. It might in the end turn out to be a tragedy, but it doesn’t have to.

This is especially worth remembering after a day in which the stock market plunged as Greece’s debt was freshly downgraded (this time to “junk” status). The Dow Jones Industrial Average fell by more than 200 points, or 1.9%. The S&P; 500 had an even worse day in percentage terms, shedding 2.3%.

But investors can’t really have been all that surprised by the downgrade of Greek debt — or at least shouldn’t have been. John Dessauer, editor of an investment advisory service called John Dessauer’s Outlook, argued in an interview last week that it was almost certain that Greece would end up defaulting on its sovereign debt, either outright or de facto.

In any case, Dessauer furthermore argued, the impact on the world economy of an outright Greek default would be fairly modest. That’s because the damage to world trade inflicted by the Greek crisis has already happened — and for the most part has been already priced into the level of the stock market.

Dessauer’s point is confirmed by a recent analysis I conducted of the stock market’s reaction to past sovereign debt crises. Interestingly, Greece’s sovereign debt crisis is hardly unique. And the stock market on average has performed quite well in the wake of past such crises.

Over the last two decades, I counted at least four major sovereign debt crises:

* The Mexican peso devaluation and associated crisis, which began in December 1994.

* The so-called “Asian Contagion” that began in July 1997, when a government debt crisis in Thailand led to a run on its currency. That in turn precipitated similar crises throughout the region, leading many to fear that the crisis might eventually spread around the world.

* The Russian ruble devaluation in August 1998, which led to (among other things) the bankruptcy of Long-Term Capital Management

* The Argentine government debt/currency crisis that began in November/December 2001

The accompanying chart is based on a composite of how the stock market reacted following all four cases, with 100 representing the stock market’s level when those crises first broke onto the world financial scene. On average the stock market was 17% higher in one year’s time (as measured by the Wilshire 5000 Total Market Index).

The chart also shows how, on the same scale, the stock market has reacted so far to the Greek crisis. Notice that, more or less, the stock market is following a similar script. In fact, even with Tuesday’s big drop in the stock market, it nevertheless remains ahead of the average experience in the wake of the four prior debt crises.

This analysis doesn’t amount to a guarantee that the stock market will perform as well this time around, needless to say. There is a big leap of faith involved in extrapolating from this — or any — historical analysis, especially one based on a sample containing just four examples.

IndexIQ is a leading developer of index-based alternative investment solutions, offering Exchange-Traded Funds (ETFs), mutual funds and separately managed accounts. The IQ Hedge Multi-Strategy Tracker ETF was introduced on March 25, 2009, and was the first U.S.-listed hedge fund replication ETF. It is designed to capture the risk-adjusted return characteristics of the collective hedge fund universe using multiple hedge fund investment styles, including long/short equity, global macro, market neutral, event-driven, fixed income arbitrage, and emerging markets.
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IndexIQ products are designed to be liquid, transparent, low cost, and accessible to a broad range of investors.* QAI, MCRO and IQ ALPHA Hedge Strategy Fund are not hedge funds and do not invest in hedge funds.

The ETFs should be considered a speculative investment entailing a high degree of risk and are not suitable for all investors. An investment in the ETFs does not represent a complete investment program.

But it turns out that a growing number of ETFs are failing to do just that. In 2009, tracking error — the difference between the performance of an ETF and its index — widened significantly, according to a recent Morgan Stanley report. U.S.-listed ETFs saw an average tracking error of 1.25% in 2009, more than double the 0.52% in 2008. The biggest offenders? Sector and industry funds, global funds, commodity and fixed-income ETFs.

So why does it matter if your ETF doesn’t do what it was created to do? Well, investors choose ETFs, instead of mutual funds or individual stocks, in order to diversify their holdings — and because they believe a broader index might perform better than a managed fund. From that perspective, tracking error can equal higher risk. In other words, tracking error can be cool when an ETF outperforms its index, and less cool when it underperforms the index.
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The big question is, how do you know when your ETF has gone astray? Every ETF calculates what’s called the intraday indicative value of its underlying index, which essentially reflects its net asset value. Investors can compare an ETF’s market price to that indicative value to see how well the ETF is tracking its benchmark, and can monitor that matchup over time using an online quote system like Google Finance.

Simply enter the symbol of your ETF with “IV” and Google Finance returns with a chart of the indicative value over the past five days. You can then add the regular ETF symbol to this chart and see at a glance how close the ETF is tracking its index. Most ETF sponsors, particularly the larger ones, provide information about the indicative value going back to the ETF’s inception.
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As Alan Segars, investment management officer of The Provident Bank’s Wealth Management Department, puts it: “Is there a certain threshold where investors should immediately sell their ETFs? Hardly. Rather, portfolio managers need to factor tracking error into a holistic investment process.” After all, some tracking error is inevitable, but you want to be sure that your ETF’s deviation matches your investment goals.

According to new research, the answer is yes. In fact, periods of rising rates may be the best time to buy.

A study to be published this fall in the Journal of Investing suggests that portfolios that add commodities after the Federal Reserve tightens the discount rate, which is the rate it charges on loans to member banks, perform better than portfolios that don’t—and lower their risk. Conversely, when the Fed cuts the rate, commodity-flavored portfolios suffer more than those without commodities.

The authors, Mitchell Conover of the University of Richmond, Gerald Jensen of Northern Illinois University, Robert Johnson of the CFA Institute and Jeffrey Mercer of Texas Tech University, studied data from December 1970 through August 2007. They added a basket of commodity futures tracking the S&P; GSCI Commodity Index to five types of stock portfolios: value, small-cap, momentum, growth and large-cap.

The commodities added to the returns of all five equity styles during periods when the Fed tightens the discount rate. A 10% dose of commodities would have boosted a small-cap portfolio by the most: 1.67% per year during the restrictive period. That helping of commodities would have added 1% to the momentum portfolio, the least among the five.

Adding commodities also significantly decreased portfolio risk, according to the study. “Commodities, over time, perform much better in a rising interest-rate environment,” Mr. Johnson says.