How to invest middle-term?

Today, the most important question for you, as an investor is: Should I cash in profits now, stay in the market or even expand positions? This is finally not easy to be answered. If you take a look at the S&P 500 of the last 10 years, you can simply discover that after reaching the lows in 2002 and early 2003 the recovery took place without significant decline in prices.


When the S&P 500 had been returned to 1000 points in summer 2003, no W-pattern had been formed and the lows were not reached again. Everybody had fear after 3 years of bear market, but nobody wanted to sell out. And while leading indicators continued to improve, it was the right choice to bet on further market improvement.

Today, the situation feels pretty much the same. After emerging from the lows and reaching the level of 1000 points, nobody wants to stand at the sideline.
Short-term we expect some range-trading – most investors want to see lower prices to load up on the buy side. As long as worldwide policy remain loose, and yields remain low, declines in prices are used to expand positions and there is still a lot of money out there. This can be seen as a healthy correction. At the end of 2003 the S&P was above 1100.

However the big challenge in the future will be, how central banks around the world, solve the situation with the easing and the flood of cheap money. No doubt, the economy will have to digest rising interest rates in the future. But this situation should not arise before second half of 2010.

As a mid-term investor you have to keep your focus on the following questions:

• When will policymakers withdraw the stimulus and how much?
  We expect a first increase in interest rates by the FED in the 2nd quarter 2010, but it will be moderate and should not make markets shy.
  
  
• Will the leading indicators continue to improve?
  We think yes, because any fiscal actions always show signs with some delay. Although, unemployment rates are on the maximum right now, the situation will improve within the next 9 to 12 month.
  
  
• Will Chinese import growth continue to accelerate relative to exports and what will tighter financial conditions in China do to growth?
  Even, within the worst times of recession, China showed a positive growth domestic product (GDP) development and is likely to return to old performance. The more interesting question is – when will China going to be overheated?
  
  
• Will inflation continue to be under control despite improving growth and accommodative policies?
  We expect yes - the centrals banks will take care about this more than ever.
  
  
• Are the better signs in the US housing market likely to persist and how will the job market develop?
  
  
• Was the recent positive surprise in the Euro-area a one-off, or is it set to continue?
  The economy in Europe should improve with lower pace than in Asia, but exports into this region would help to further improve the local situation.

So, what’s the conclusion of the story?
As many others, we expect a further market improvement in the mid-term, not without some declines in the short-term. But this can be opportunities to expand your long positions, not without hedging against set-backs.

Therefore you should buy put options with enough leverage to secure your long positions. For example – if you like to invest $10,000 on the buy side and like to assure against a 30% decline – which equates to $3,000 - you should spend $300 into put options with a tenfold leverage.

Next time we'll explain the calculation of options leverage in detail.