5 Effective ETFs to Hedge a Frothy Stock Market

In the minds of many, our stock market is a bit bloated at its current levels. Despite weak fundamentals, major benchmarks are near pre-recession levels which is more than likely the result of multiple rounds of QE artificially boosting the economy. Pre-recession, GDP growth was at about 3.6% at the end of 2007, while unemployment sat around 4.6%. Now, GDP growth is at 1.7% (revised) with unemployment staying comfortable above 8% (if you need more stats, there’s plenty where that came from). Stocks have surged since the recession, but the fundamentals of our economy have only marginally improved [for more economic news and analysis subscribe to our free newsletter].

You could almost say that the only thing QE benefits is the stock market, creating a false sense of security for investors everywhere. Expert analysts have been predicting bone-crushing recessions on the horizon, as they feel that the QE crutch will eventually be removed and bottom out stocks. For those who believe that our current stock market is a bit overvalued, we outline five ETFs to hedge against a possible fallout or economic downturn.

PowerShares DB Agriculture Fund (NYSEARCA:DBA)

This ETF holds futures contracts for some of the most popular and liquid agricultural commodities. Currently, the fund grants the most exposure to corn, soybeans, and sugar, but others like cotton and coffee still get a fair representation. The attraction to DBA comes from the fact that food prices will always keep up with inflation, as they are often the first sign of such an environment in the first place. For the most part, food demand is inelastic whether we are in a recession or not, allowing this product the potential to perform well even in times of economic turmoil. In 2008 when the S&P 500 lost nearly 36%, DBA was down just 19% by comparison.

SPDR Gold Trust (NYSEARCA:GLD)

A no-brainer. Gold is the ultimate hedge against falling stock markets as it not only has all of the benefits of a standard commodity, but investors tend to flock towards metals given the safe haven appeal. GLD has nearly $75 billion in total assets, making it the second largest ETF in the world. The fund offers exposure to physical gold at a cost of 40 basis points, but there has been quite a controversy as to whether or not the fund actually holds the gold it claims to. The decision on whether or not to trust GLD is up to you, but it should be noted that the fund has never turned in a losing year since its inception [see also Three Reasons Why Gold Is Overvalued].

iShares Silver Trust (NYSEARCA:SLV)

Another physically-backed fund, SLV is the most popular fund for obtaining exposure to silver. Investors should be aware that silver has a tendency to be more volatile that gold which can be good or bad depending on the year. If it is any consolation, investing legend Jim Rogers recently touted silver as a better investment than its precious metal counterpart stating that he feels this white metal has more upside than gold. To give you a quick idea of how hot and cold this fund can be, SLV lost 23% in 2008, only to jump by nearly 130% over the next two years.

United States Commodity Index Fund ETV (NYSEARCA:USCI)

Contango is an inevitable phenomenon in the commodity world and many spend their efforts trying to avoid it. This fund has been dubbed the “contango killer” as it focuses its efforts on investing in 14 different commodity futures while trying to avoid falling prey to an upward sloping curve. USCI features a dynamic basket of holdings that changes on a monthly basis based on observable price signals. It screens out commodities that show the most significant backwardation or moderate contango. USCI ensures diversification by allocating assets to each of the six commodity sectors (grains, softs, industrial metals, precious metals, agriculture and livestock) each and every month. Avoiding contango and investing in the broad commodities space can ensure you keep up with inflation while not giving up gains to a less-than-ideal futures curve [see also What Is Contango?].

iPath S&P 500 VIX Short Term Futures TM ETN (NYSEARCA:VXX)

Volatility has become one of the most popular asset classes after the widespread introduction of ETNs that invested in their futures. VXX alone trades more than 44 million times each day and is one of the most popular speculative tools on the market. Obviously this fund is extremely dangerous to hold in the long-term, but when hedging against a fall-out in the near future, few funds will be able to outperform VXX. The fund has never finished a year in the green, yet another reason to never hold it long-term, but when markets hit a speed bump like they did last August, this fund soars to unthinkable heights. For those who can stomach the hefty movements of VXX, make sure you keep a watchful eye on a daily basis as it can turn sour on a dime.

This article was originally written by Jared Cummans, and posted on CommodityHQ.