A guest column this morning in the Wall Street Journal by a fellow from the Cato Institute is the best piece I have read on the Europe’s crisis in months, perhaps years. Unlike the right-wing biases that make the editorial pages of the Journal increasingly irrelevant to intelligent discussion of almost anything, and unlike the right-wing opinion posing as fact that often come out of Cato, this extremely well-written column was spot-on. It did not adhere to the rules followed by the Crowd writing for this part of the Journal.
What did this guest columnist say? Greece is going to leave the euro, sooner or a little bit later; the real issue is Spain. More importantly, the macro issue for eurozone is the creation of a monetary union before a fiscal and true federal union of 17 states in Europe. Translation: Greece will leave, Spain may and if Spain goes, so goes the eurozone. Perhaps the EU.
The facts — not opinions or ideology — overwhelmingly support this view. The issue today — and for the next couple of years at a minimum — is what can investors do to not just shield themselves from European Madness but to benefit from it?
A savage recession
Let me put the benefits first. The crowd on this side of the pond is beginning to accept that the U.S. may go into a recession. That has been inevitable for many months and a statistic familiar to nerds (like me) hit the headlines yesterday: The wealth of the average American household fell 40% in the last five years. Combined with other data, a savage European recession around the corner and therefore a slowdown in China, and you have a recession. No, a recession is not a benefit. But it may surprise traders and analysts — it will surprise traders and analysts — and there will be a selloff or decline this year, perhaps next year as well, setting the stage for a big spike in the market sometime on or before 2015-2017. As the market bottoms, value will be more evident and long-term investors will be able to buy into the prices at once-in-a-generation prices.
What are the downsides? What I just wrote: It is going to be rough going for an extended period of time in the real world and this will spill over into markets. Investors, especially those looking for and needing income, are going to see high-yield stocks — most high-yield stocks — take hits with the market; bonds are also in bubble territory. Most will follow the crowd and buy the wrong things, collecting dividends but watching their core capital shrink because they picked the wrong stock, the wrong bond, the wrong ETF, the wrong high-yield mutual fund.
Invest in volatility and tumult
What should they invest in? The volatility and tumult they know is coming. There are two ways to do this. Buy the iPath S&P 500 VIX Short-Term Futures ETN (VXX) and sell calls against it. This the ETF for the VIX, that measure of market volatility known as “the fear index.” The VXX has gone from the high 40s last year to around $19, and if you check the chart it has never gone below $15. Better yet, sell puts on the VXX. Here is what you get if you do:
- If you sell a July $15 put, you will get around 3.5% return on capital an annualized rate of 42%.
- If you sell an August $15 put, you have a 5% return on capital, an annualized rate of 30%.
- If you sell a September $15 put, you have an 8.3% return on capital, an annualized rate of 56%.
- If you sell a December $15 put, you have a 14% return on capital, an annualized rate of 28%.
- If you sell a January 2013 $15 put, you have a 17% return on capital, an annualized rate of 29%.
- If you sell a January 2014 $15 put, you have a 30% return on capital, an annualized rate of 19%.
And after you do something like this, think gold and its cousins, the gold miners — and this is coming from someone who routinely dismisses the gold crowd and the gold bugs. More next week on how to do this to generate income.