The Fed Won't Stop The Party Just Yet

  ⚠ This article is more than 13 years old

“Try not to become a man of success, but rather try to become a man of value.” — Albert Einstein

Ben Bernanke is back for yet another close-up this week, and in spite of a certain degree of dissent amongst the Fed ranks, chances are better than even-money that the press conference that follows this week’s gathering of the Federal Open Market Committee Meeting (FOMC) will find Big Ben indicating that the super low interest rates, strong stimulus tack will remain in place.

After all, why would the head of the Fed try to upset a relatively positive applecart? Indeed, the Fed’s business is the economy, and, relatively speaking at least, business is good.

Wall Street is thriving at the moment, as indicated by the performance over the last month of the major indices. The Dow Jones Industrial Average (DJIA) has ended in the black no less than 13 out of the last 15 sessions. Not only has it hit record highs, it is on a fierce four-week winning streak. As of last week, the Dow was up over 11% year-to-date. Close behind is the benchmark S&P 500 Index (SPX), up over 9% YTD. The tech-laden NASDAQ Index (COMP) trails the trio, and is up over 7% YTD.

The economy seems to be showing sustained signs of life, in spite of the stubbornly high rate of unemployment. Economic news last week included slightly better-than-expected retail sales numbers, which was apparently just enough to confirm for investors that the recent Bullish data– showing incremental though limited growth in the arenas of consumption, U.S. exports and private sector investment– does indeed seem to indicate a trend.

So all’s well in investorland?

Perhaps, but one doesn’t last in investorland for long unless one has learned to be prepared for the market’s frequent and inevitable surprises.

Hedges, in other words, should be considered anytime Big Ben approaches the microphone, whether because of his utterances or of those made by other members of his club.

So, in positioning yourself for the possibility that the Fed hawks will try to make the voice of dissent heard through subversive whispers, and in anticipation of the possible sharp and sudden downward dive in the market that would accompany such chatter, the addition of some volatility insurance would be considered prudent.

For all its flaws, and there are indeed many, the VXX (S&P 500 VIX Short-Term Futures ETN) still manages to serve as a functional hedge against sudden shifts in the Wall Street headwinds.

A VIX derivative, VXX tracks the S&P 500 VIX Short-Term Futures Index Total Return. Though VXX is not recommended here as a long-term hedge due to the intrinsic limitations of its structure, it does share some of the attributes of explosiveness of VIX futures, meaning that when the market shifts fast in either direction the VXX moves in a similar, amplified fashion.

Bottom line: A sudden market drop would result in a big gain for a long VXX position. Remember, the VXX generally goes up as the market goes down, and vice versa.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Additional disclosure: I am long VIX futures via options