Investment Advice for the GE Hangover

Going into Friday’s trading all of our indicators were still in the green; although the market internals gave us an early warning on Thursday. Despite big gains, the number of companies setting new lows Thursday outpaced new highs on the NYSE (NY), NASDAQ (QQQQ) and the S&P (SPY).

After GE (GE) disappointed Wall Street and investors alike, 2 of our most important indicators moved into sell territory. Our Momentum and Market Leadership models are telling us to be more cautious moving forward.

We believe the GE hangover could last a little while. Many banks are set to report their earnings this week and we are not too confident the likes of Citibank (C) and Wachovia (WB) will provide the medicine the market needs.

The Correct Call recommends taking some money off the table until conditions improve. We would lighten up or sell index related ETFs, like Ultra QQQ ProShares (QLD), PowerShares QQQ Trust (QQQ), iShares Dow Jones Transport (IYT), SPY and Ultra S&P500 ProShares (SSO). We would continue to hold the industrial ETFs PoweShares (PRN) along with the Dividends Achievers portfolio (PFM).

More aggressive investors might consider moving some of their dollars into ETFs that go up when the indexes go down:

• ProShares Short S&P 500 (SH): objective is to produce the inverse of the S&P’s performance. For example, if the S&P moves down 1%, SH should move up 1%.
• ProShares Ultra Short S&P 500 (SDS): objective is to produce the 2x the inverse of the S&P’s performance. For example, if the S&P moves down 1%, SDS should move up 2%.
• ProShares Short QQQ (PSQ): objective is to produce the inverse of the NASDAQ 100’s performance. For example, if the NASDAQ moves down 1%, PSQ should move up 1%.
• ProShares Ultra Short QQQ (QID): objective is to produce the 2x the inverse of the NASDAQ 100’s performance. For example, if the S&P moves down 1%, QID should move up 2%.

Disclosure: none

Comments

[WilliamEdwards]

I found that below the surface of “Proshares” ultra products resides an unregulated black box full of derivative contracts, a chimera of creative imagination. I voted with my dollars and stopped using these instruments. I will be buying gold instead.

It's only on the surface that “Proshares ETF Ultra Short ETF's” appear to be the product of choice for navigating a bear market. With what other instrument can you double short an Index while receiving a three percent yield? Are “Proshares” too good to be true?

Normally you and I would be severely constrained to short an index because we would need to borrow the underlying shares, pay the dividends for those shares, and manage restrictive margin requirements. A Proshare ETF such as MZZ addresses every limitation to the problem of shorting the market or an index. You need very little cash to short the market or a sector, your holdings are recorded in your account as margin eligible long positions, and instead of paying a dividend you get paid a dividend. It sounded too good to be true so I read the prospectus. I had to read the prospectus many times and the net result was that it was useless.

Because, the “Proshares” prospectus provides very little decipherable information as to structure; I was forced to postulate. I would challenge Proshares to correct this posit by providing fact and making full disclosure.

Perhaps;

LLC #1 and LLC #2 have entered into reciprocal contracts to swap cash flows based on an index. Perhaps these LLC's are off balance sheet shell companies crafted for this specific purpose. These LLC corporations and the underlying contracts are black box entities not subject to disclosure. These LLC's are not regulated. Sales of shares are put into ETF form and sold into the market to generate a cash pool from which fees are collected and interest is derived and then swapped. These shares can only be redeemed in large blocks intentionally making them illiquid as to prevent a possible a run aka Bear Stearns. A third party brokerage firm, JP Morgan, gets tasked with assigning a net asset value to these contracts. These contracts are aggressively marketed on financial TV (CNBC lists Proshares in orange ticker!). Please remember the Enron commercials and the catchphrase “Why?” Perhaps LLC #1 provides a floating interest rate to LLC #2 while LLC #2 provides LLC #1 with an equity index return. The security trades on the exchange and we believe as investors that risk has been negated entirely through netting. The regulators are nowhere to be found, they don't understand that Ponzi may be at play. What exactly are S&P Midcap 400 Swaps? Please tell me as I can only guess.

MZZ – Proshare Double Short S&P Midcap. Holdings..

Security Description
Notional Value
Market Value
Shares/ Contracts
S&P MIDCAP 400 SWAPS
(396,543,080.19)
-
(497,045.72)
MID 400 E-MINI 20/06/08
(28,632,840.00)
-
(358.00)
Net Other Assets / Cash
-
212,627,636.57
212,627,636.57