ETF Periscope: Spain Remains a Pain For Wall Street

A child of five would understand this. Send someone to fetch a child of five.”—Groucho Marx

For a market that has spent a good portion of September exploring new highs for the year, there seems to be a lingering apprehension on Wall Street that October could see a return to increased volatility.

Though last week saw a slight fall-off from some lofty third quarter numbers, many investors had to feel good if they had ignored the old adage, “sell in May and go away.” As it turns out, such advice would have led to a substantially lighter portfolio.

If investors kept pace with the key indexes, the profits seen over the last three months leaned towards the substantial. The benchmark S&P 500 Index (SPX) gained 5.8% during that period, while the Dow Jones Industrial Average (DJIA) ended 4.3% in the black. Both paled beside the tech-heavy Nasdaq Composite (COMP), which improved by 6.2%.

On the other hand, there may be more reason to expect a continuation of the sell-off that was seen during last week’s market action.

The upcoming week’s cycle of economic data and eurozone news will strongly set the tone for the markets, and, with levels of volatility beginning to percolate up from September’s YTD lows, any combination of sour news could cause investors to lock in gains and back off from equities and into less risky vehicles such as cash.

The jobs report from the Labor Department isn’t due until the end of the week, but it will remain on investors’ radars right up to that point. Any sign that the job market is deteriorating will support the current narrative of a sagging economy, and could tilt the market towards the Bears.

Another potential needle-mover will be Ben Bernanke’s monetary policy speech. Wall Street will be paying close attention to the Fed Chairman as he beats the drum for support of his recent QE3 bombshell that sent the market upward, though perhaps to a more limited degree than might have been expected.

Apparently, unlimited stimulus doesn’t have the effect one might expect. It’s possible that this time around investors want to see how QE3 impacts the actual economy, as opposed to just the traders on the Street.

What might turn out to have the most significant impact on the market next week could come from Spain, as its government wrestles with the question of  “to be, or not to be, a borrower of the ECB.”  Prime Minister Mariano Rajoy is reluctant to take up the ECB’s offer to help buy the country’s debt, as such a move would require Spain to agree to a series of harsh austerity measures that are hardly popular with the populace. The recent wave of protests by the Spanish citizenry is an obvious indication of the lack of popularity of such a move. Spain has been reeling from several years of the highest unemployment rate in the eurozone, topping 25%, and the salary freezes and additional spending cuts that are likely to accompany any ECB bond purchases of Spanish debt are generating huge levels of resistance to such an agreement.

Right now, Wall Street expects Spain’s government to acquiesce, bite the bullet, and take the money. Should a different outcome occur, the uncertainty that has surrounded the viability of the eurozone for the last two years could quickly resurface. Concerns that the eurozone will fall deeper into recession—and the subsequent impact on the global economy that would likely follow—will strongly influence how the remainder of the year ends for Wall Street.

What the Periscope Sees

There are such a wide variety of wildcards in the deck at the present time that directional bets may be akin to betting on red or black on a Vegas roulette wheel.

Does that mean that investors should retreat to the sidelines until some of the current uncertainty is removed, either through decisive election results, better economic numbers, or a decision by Spain to ask the ECB for a bailout? Remaining in cash is never a bad option, if your concern is risk avoidance and capital preservation. Sleeping like a baby has its own rewards.

On the other hand, a survey of the current investment landscape, particularly one with a Eurocentric perspective, might yield a few interesting possibilities. To a large degree, the Nordic nations of the European Union have proven somewhat resistant to the problems of the eurozone. NORW (FTSE Norway 30 ETF) is up over 20% YTD, while EWD (MSCI Sweden Index Fund) has notched gains of over 12% YTD. Either would be a way to bet that the health of the eurozone will improve, at least for the near term.

But what if it doesn’t? What if Spain stays understandably reticent about submitting to austerity demands that would accompany bailout funds? Or what if the ECB remains at odds with Germany over the specifics of what form the proposed bond purchase program finally looks like?

A good hedge to counter a sharp downside swing, one that would result from any new round of eurozone unraveling, would be EWP (MSCI Spain Index Fund). MSCI is down 8.5% YTD and would obviously get hit hard should Spain fail to take what investors consider to be the necessary action to tackle its combination of sovereign debt and banking liquidity issues.

Still undecided? Consider pairing one of the Nordic ETFs with MSCI. Go long the Nordic half of the pair, short the Spanish ETF.

ETF Periscope

Full disclosure:  The author does not personally hold any of the ETFs mentioned in this week’s “What the Periscope Sees.”

Disclaimer: This newsletter is published solely for informational purposes and is not to be construed as advice or a recommendation to specific individuals. Individuals should take into account their personal financial circumstances in acting on any rankings or stock selections provided by Sabrient. Sabrient makes no representations that the techniques used in its rankings or selections will result in or guarantee profits in trading. Trading involves risk, including possible loss of principal and other losses, and past performance is no indication of future results. 

ETF Periscope
daniel / Tag: DJIA, SPX, NASDAQ, COMP, NORW, EWD, EWP Fed, Eurozone, ECB /