Why ultrashort ETF's might still suck in a deep recession
April 02, 2008
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RELATED TICKERS: SDS
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I am not going to buy ultrashorts, even though I think the economy is bad now and going to get much worse. "Why not?" I hear you asking. Well, quite simply, no matter how much the real value of the stock market goes down, the value of the dollar can go down just as much. "So?" So allow me to illustrate what will happen if you invest in QID (an ultrashort ETF promising double the inverse of the Nasdaq 100) and the real value of the Nasdaq 100 goes down 10%, and the value of the dollar goes down 10%.
You invest $1000 in QID at $50/share and get 20 shares. For the sake of argument, let's say the value of the Nasdaq 100 goes down 10%. So your QID is supposed to go to $60, right? Not so fast. What if inflation is 10%? Okay, so your 20% gain is like a 10% gain in real value, right? Again, slow down. It's more complicated than that. I said the value of the Nasdaq 100 went down 10%, not the price. So with 10% inflation, the notional value (or price) of the N100 stayed the same, even though in reality it is worth 10% less than it was.
Now, I may be mistaken, but I'm pretty sure that QID's moves are based on the change in notional value in the N100. That is, when the price of the N100 stays the same, it doesn't matter what the inflation rate did to the actual value, the price of QID remains relatively unchanged (except that it drops about 1% due to its expense ratio).
Well, that's not such a disaster, is it? Yes, it is. Remember the inflation? Your QID investment dropped only 1% (from 50 to 49.5), but your purchasing power dropped from $1000 to about $890. You just lost about 11% of your purchasing power.
Okay, okay, but what are the odds of 10+% inflation? I would say pretty good, considering that both Republicans and Democrats seem bound to keep uncapped entitlement spending growing at a rate that vastly outpaces GDP growth, and taxes are way less popular than inflation as a way of paying for it. Inflation, from a political point of view, also has a huge side benefit of making a stock market appear stable or growing, even as it is declining in real value. If the inflation is even steeper than the decline in real value in the underlying index, an investment in the underlying index (QQQQ) can decrease in purchasing power while QID loses purchasing power even faster, as the N100 makes notional gains.
That's why you won't see me investing real money in ultrashort ETF's, even though I believe we're in the early stages of one of the three worst recessions in a century. I'm going to be looking for foreign dividend stocks, gold and silver mining stocks, and especially dividend-paying foreign gold and silver mining stocks, unless someone like TMFBent or downwithinfidels has a better idea.
P.S. Even in a bad inflationary recession, individual domestic stocks that do business in, and report earnings in, the affected currency can nonetheless dramatically increase their owners' purchasing power. This is especially true of small caps with world-changing innovation and companies that profit from the government largesse that causes the stagflation.
P.P.S. Apparently CAPS doesn't like for articles to single out QID in the "Related Tickers" field.
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