Rules for Investing in Stormy Weather

By Chloe Lutts

Hurricane Preparations

Hurricanes and Investing

A Fund for Stormy Markets

Last Friday, I went to the grocery store around noon to buy something for lunch and ingredients for dinner. It was an utter madhouse: shopping carts and stacks of food blocked the aisles, and people were everywhere.

It wasn’t until I got home that I realized why: the hurricane heading toward North Carolina was now expected to slam straight into New York the next day. Perhaps I should have bought more food.

I actually did decide to go back to the grocery store for more supplies a little later, and it was even crazier. There were no shopping baskets to be had, and the check-out lines were beginning to wind down the aisles. The canned soup shelf was becoming noticeably bare.

It’s now well after the storm, and everything turned out more or less fine. There’s still a fairly large tree branch on the sidewalk, but the view from my window is otherwise normal–largely because the storm was not as fierce as expected by the time it hit New York, and to a lesser extent because of our over-preparation, the damage was minimal.

Hopefully people won’t take this as an excuse to under-prepare for our next extreme weather event.  

I did learn something though: surviving a hurricane is not so different from surviving choppy markets. So today I bring you some hurricane lessons that can be applied to investing.

1)  Stay Informed

Knowing what to expect allows you to make better decisions, whether they’re about your portfolio or your pantry supplies.

The Weather Channel was the top-watched TV network this weekend–I’m sure part of that was simple voyeurism, but I know I was checking back frequently for updates on what to expect from the storm.

I had made most of my relevant decisions by Friday night–I bought more food, and put some tap water in empty bottles–but I kept checking back anyway to see if there was any new, relevant information.

My friends who live a few blocks away had a trickier decision to make–they were about a half-block from an evacuation zone, and were considering coming to stay with us. They had to keep an eye on the forecasts for longer than we did, but after consideration of all the relevant factors, including their height above sea level (30 feet) never decided evacuation was necessary.

Likewise, when investing, having all the relevant information is key. When you’re expecting turbulence, it pays to keep a close eye on the market, timing tools or indicators and your stocks. They’ll let you know when you need to do something.

However, another important lesson I learned from my hurricane preparations was:

2) Know When to Do Nothing

Most of the hurricane preparations I made came at no significant cost to me. I bought way too much food, but I invited a bunch of friends over to dinner the next night so it didn’t go to waste. Putting water in empty containers cost nothing more than a few minutes of my time.

After that was done though, I was left sitting on my hands for much of Saturday, watching the Weather Channel and wondering if I should do something. But there was really nothing else I needed to do. I could have bought another flashlight, but I didn’t need one, or I could have taped my windows, but I really didn’t need to do that.

So I did nothing, and now I’m glad. Not everyone is in the same position: two men quoted in The New York Times yesterday complained about the hype surrounding the storm. One had spent $200 on supplies Friday, and the other spent two hours going to three grocery stores to find a loaf of bread.

Investing during rough or threatening markets can feel similar: It’s hard to sit on your hands when a storm is coming. But sometimes doing nothing is actually the best choice.

So make adequate preparations that are worth the cost: putting in stop loss limits is a good example. But don’t feel compelled to do something costly–like selling your stocks, or shorting the market prematurely–just for the sake of doing something.

Which leads to our next lesson:

3) Stay Calm

There was a palpable feeling of tension leading up to the hurricane’s arrival, especially at the grocery and hardware stores (I was there Friday for a completely non-hurricane-related reason). But it’s important not to panic in situations like these, because panic leads you to make poor decisions.

Finally:

4) Be Patient

Hurricanes are famous for the “eerie calm” inside the eye of the storm. On one episode of The Simpsons, a hurricane passes over Springfield, and Homer ventures outside when the eye arrives, thinking the storm is over. A few moments later, he’s almost blown away and his family has to drag him back into the basement.

Choppy markets almost always have their own “eye of the storm,” a period when it seems like it might be okay to get back in the market.

Earlier this month the market made just such a gesture, recovering almost half of its prior losses, but it soon failed again, as you can see below.

Unlike a hurricane, which only has one eye, weak markets can do this fake-out multiple times before they really recover. So don’t be like Homer and rush outside at the first sign of calm–be patient and wait until you’re sure the storm is really over. Wait it out.

I know a lot of these rules are no fun: sit on your hands, wait it out, stay calm. Isn’t there anything you can do to take advantage of the storm? One entrepreneurial New Yorker picked flashlights on Saturday; he set himself up outside a hardware store with a box of them for sale.

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Investors have a way to benefit from stormy weather as well. The iPath S&P 500 VIX Short-Term Futures ETN (VXX) outperforms when market volatility is high. It was recommended by not one, but two experts in the most recent Dick Davis Investment Digest.

Here’s what Benjamin Shepherd, editor of Global ETF Profits, wrote:

“The Chicago Board Options Exchange Volatility Index, better known as the VIX, tracks the S&P 500’s volatility. This index, which is also called the Fear Index, outperforms when the S&P 500 runs into trouble. When the S&P 500 crashes, the VIX turns in equally large gains. This exchange-traded note (ETN) tracks the performance of a basket of short-term VIX futures with an average maturity of one month. As a result, it sports a negative correlation to the S&P 500 and performs well when the S&P 500 declines. By the same token, when markets are flat, the ETN’s performance also remains flat. The fund’s 0.89% expense ratio is fairly high, but the fund features little tax exposure and investors only pay capital gains when they sell the fund. This makes the ETN a cost-effective hedge. Buy S&P 500 VIX Short-Term Futures ETN at current prices.”

And here’s a recommendation from Options Trading Coach, edited by Ian Cooper:

“In the days following the Downgrade Heard ‘Round the World of 2011, VIX ran to a high of 48. That’s overdoing it. There’s only been a handful of other times it managed a read above 45. The VIX ran to a high of 89.5 (October 2008) during the 2008 financial crisis. But typically, even in some of the worst of times, it’s peaked out right around 50. The VIX ran to 49.53 in October 1998 on the Long Term Capital Management Crisis. It ran to 49.35 after the 9/11 World Trade Center attacks. It ran to 48.64 in October 1997 on the Asian financial crisis. It ran to 48.46 in July 2002 on the tech crash. It ran to 48.20 in May 2010 on the European debt crisis. And it ran as high as 48 during the current U.S. debt rating downgrade, credit crisis. And in the wake of many of those, you could have cashed in quite nicely, as volatility dropped and the markets surged. Are you feeling confident it’ll happen again? Near-term, we’re on the fence–especially with the Merkel-Sarkozy meeting to avert a growing debt crisis on deck this week, along with reads from the Philadelphia Fed, CPI and PPI reads, existing home sales, leading indicators, housing starts, and building permits. There’s great doubt that a European debt deal can get done to prevent insatiable volatility, near-term. Longer-term, though, as fear reaches its pinnacle, when the VIX drops, it’ll drop hard. The Best Way to Trade: Hedge by playing the iPath S&P 500 VIX Short-Term Futures ETN (VXX) underlying with a hedged short. … And, as always, do not risk the house. Do not risk more than you can afford to lose. Play it safe–and play it smart.”

As Ian Cooper pointed out, this is a risky investment, so be careful. And remember the four rules for investing in stormy weather.

Wishing you success in your investing and beyond,

Chloe Lutts
Editor of Investment of the Week

P.S. Chloe Lutts is the editor of Dick Davis Investment Digest, where you’ll find dozens of great stock recommendations twice each month. Chloe uses her expertise to select the very top investments from hundreds of the best financial newsletters, saving you time and money! Get the top stocks ideas from the best minds on Wall Street for just pennies a day when you subscribe. Click here to learn more!

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