Four Subprime ETFs

The sub prime contagion is sweeping the world like a fast moving storm and leaving a trail of destruction that stretches from New York to New Delhi. The Fed is nervous; Wall Street is nervous and you should be nervous because even though you may not own a home facing foreclosure, it has and most likely will continue to affect the investing landscape for months to come.

What's the Big Deal?

Here are just a few of the scary facts that make this the "biggest deal" to come down the track in quite sometime:

• On October 30th, the widely regarded Case-Shiller Home Price Index reported that through August, 2007, home prices nationwide registered their 8th consecutive month of negative annual returns and Dr. Robert Shiller stated that "home prices show no real signs of slowdown or turnaround."
• In September, the backlog of existing homes for sale jumped to a 10.5 month supply according to the National Association of Realtors.
• For September, Case-Shiller reported home price declines in all 20 major cities they cover and this was the largest quarter to quarter decline in the last twenty years. Prices fell a record 4.9% from a year ago, and historically it has taken approximately 8 years to recover from declines of this magnitude.
• Approximately $800 Billion in sub prime mortgage loans will reset to higher interest rates over the next 13 months.
• Many states are experiencing foreclosure increases in triple digits year over year. I could go on and on with these kinds of troubling facts, but certainly the picture is clear; experts agree that the unprecedented U.S. housing bubble is rapidly imploding and all indications are that we haven't hit bottom yet..

Why Should You Care?

Because consumer consumption is 72% of GDP and much of his spending has been fueled by the "wealth effect" of his appreciating home.

"Equity extraction," the capital taken from peoples' homes accounted for more than $1.Trillion in disposable income over the last 5 years. While nobody can predict the future, it's at least a logical possibility that a consumer feeling pinched by a decline in his wealth might pull back on his spending, and that if he does, the economy might feel the effects of that reduced consumer activity.

Winners and Losers

Just as there are always two sides to every story, there are two sides to every economic situation and financial macro development. People who have lost so far have been hedge funds and institutions invested in sub prime debt and homeowners and "flippers" who bought at the top of the market.

Recent trends have been a decline in home values, a decline in interest rates and a weaker dollar; investors on the right side of those trends have profited. For instance, investors in bond index ETFs have profited from the decline in interest rates and the "flight to quality" in November as the stock market dropped.

Here are some of their performance numbers for November through 11/26/2007:

• iShares Lehman Aggregate Bond Fund (AGG): +1.1%
• iShares Lehman 10-20 Year Bond Fund (TLH): +3.3%

And in the financial and real estate arenas, investors who own positions in inverse ETFs have fared well for November through 11/26/2007:

• Proshares UltraShort Financials (SKF): +30.1%
• Proshares UltraShort Real Estate (SRS): +33.4%

Looking at these numbers, it's easy to see that, as always, there will be winners and losers emerging from this situation and, as always, investors who can correctly identify the predominant trends will have the opportunity to take advantage of them. The sub prime mortgage debacle and implosion of the U.S. housing market are far reaching macro events and every investor needs to be aware of the potential pitfalls and opportunities this situation presents.

Disclosure: none

Comments

[Lisa]

I didn't know that there was an ultrashort real estate ETF -- thanks. Great article.

[goatfarmer]

Shorts for all occasionas at Proshares:
www.proshares.com/fund...=
just in: emerging markets shorts EUM
Oil and Gas Shorts: DUG (with trading volume around 800k last session)
Bermuda Shorts.....