How to Profit from the Wide World of Indices
Soroush is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Think following the S&P 500, the NASDAQ, and the Dow Jones Industrial Average is a bit monotonous? Even if you’re not a hipster, we have some good news for you. In the wide world of indices, there are more choices than even Chuck Norris could wrap his mind around (though here’s a few of the action hero’s favorite stock picks). Back to the point, some indices are exotic, others are more mainstream, but each provides a unique glimpse at the state of the economy. Yes, most do not monitor company performance in the traditional sense, but they still give a tangible understanding of the markets. Below are three such indices that will help you grasp a better understanding of our current economic environment; they may even boost your portfolio.
Released monthly, the Consumer Confidence Index (CCI) reflects the opinions of 5,000 randomly sampled US households regarding their current and future employment conditions and spending habits. The Conference Board conducts the research to compile the CCI, but the information in the index is used by the Federal Reserve to determine target interest rates. The benchmark year for the CCI of 1985 is associated with an indexed value of 100. As of June 2012, the CCI is at 62.0, which reflects a 2.4 point drop from May 2012 and marks the 4th consecutive month of decline.
When you look at the CCI, you should be wary that it covers both the current consumer environment and an expectation for the next six months. The CCI can be broken down into the Present Situations Index and the Expectations Index, and although the former is mostly retrospective and already factored into current stock performances, the latter can be a more useful tool to investors.
For the month of June, the Expectations Index went down 1 point to 72.3 percent while the Present Situation Index went up almost 2 points to 46.6. This reflects the current positive performance of companies while consumers are growing more pessimistic of the upcoming six months. Despite last month’s movements, however, the CCI is still mostly help up by the Expectations half of the index, meaning that consumers are more confident of economic recovery than they are of the present situation – although less are holding this belief.
While you cannot trade any financial products that are tied to the performance of the CCI, you can look at how the Expectations Index is doing compared to the Present Situation Index and make your calls from there. If the Expectations Index surpasses the Present Situation Index, then that adds confidence to those long calls on your favorite stocks. In order to make a few blanket trades from this situation, ETFs like the SPDR Dow Jones Industrial Average ETF Trust (NYSEMKT: DIA) or the PowerShares QQQ (NASDAQ: QQQ) represent good options. For a refresher course on how to make the most money off of ETFs check out WealthLift’s ETF Education Center. Over the past month, the DIA is up by a slight 0.5 percent, while the QQQ has been down 0.1 percent. Ardent investors would be wise to monitor this month’s CCI release, as further decline in the Expectations Index could warrant further sell-offs.
Of all the commodities indices, the Thomson Reuters/Jefferies CRB is the most well-known. It has been around for over 50 years since the days of drive-in movies and beatniks, although its components have changed over time. After the latest revision to the index in 2005 (when it earned its current name), 19 commodities are represented in this index, and energy-related commodities represent the largest portion. Crude oil prices account for 23%, while gold is around 6% and orange juice (of all things!) is only 1%. Prices of futures contracts of up to six months for these commodities are accounted for in the current TR/J CRB. Prior to 2005, all commodities received equal weight when calculating the index.
The Jeffries CRB Global Commodity ETF (NYSEMKT: CRBQ) offers the closest trading option for the TR/J CRB, and the index prior to the 2005 adjustments is tradeable through the Greenhaven Continuous Commodity Index Fund (NYSEMKT: GCC). Theoretically, the diversity of commodities offered within this index – gold and its “safe haven” associations, crude oil and its “growth indication” associations – gives the impression that this would be a safe investment option. Be careful, however, as the price of the CRBQ ETF has fluctuated over 50% in the past year.
The primary measurement of market volatility is the VIX index, which tracks the volatility the S&P 500. Very superficially, the VIX is calculated based on the pricing for options on these S&P 500 stocks and is used to measure volatility over a 30 day period. The VIX is referred to as the “fear gauge” in more colloquial terms because periods of economic uncertainty are often coupled with investors moving from the stock market to “safer” assets like bonds, and the greater selling activity leads to greater volatility in the market. Thus, the VIX usually moves inverse to the S&P 500.
Although the VIX index has been around since 1993, it was only a decade later that financial products associated with the VIX started trading on the market. There is no financial product that trades directly on the VIX, but futures contracts on the VIX were introduced in 2004. The iPath S&P 500 VIX Short Term Futures ETN (NYSEMKT: VXX), which holds a long position on the next two months of VIX futures, is the most popular product associated with the VIX. It has a double leveraged “cousin” in the iPath Long Enhan S&P 500 VIX MT Fut ETN (NYSEMKT: VZZ), which investors should definitely not look into as a long term asset, although short term gains can be quite lucrative.
While these are just three of the indices available in today’s highly analytical marketplace, they do represent a few ways that investors can track the state of their surrounding environment. Indices like the CCI and the VIX are decent predictors of the future, though the best approach may be to trade some of the ETFs and ETNs described above. For more trading ideas, check out WealthLift INSIDER today.
This article is written by Amber Yuan and edited by Jake Mann. They don't own shares in any of the companies mentioned in this article. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.