Strengthening Economy Vs Increasing Geopolitical Risks: BBY, AMZN, EUO, SDS, VXX

December 21, 2010, 08:18 am ET, BY Patrick- Contributor, Stock Traders Daily| Editor: Thomas H. Kee Jr. (Follow on LinkedIn)

There is no shortage of economic indicators on the Street. We have multiple readings on the labor markets, housing markets, durable goods orders, consumer and business sentiment, inflation, and geographic manufacturing data. Each piece of data on its own is fairly limited in its use when attempting to make an assessment on the economy as a whole, but, when multiple pieces of data are strung together, a clearer picture emerges.

Even the staunchest of bears would have to agree that, with the exception of the housing market, the picture that has been emerging is one that depicts an economy that is picking up steam. The most recent evidence came on December 17 when it was reported that “The Index of Leading Indicators” rose 1.1% in November, the strongest increase since last March. The most significant contributors to the positive report were the pace of deliveries, interest rate spread, and jobless claims. Armed with a steady influx of encouraging economic data, investors have been more willing to put risk on the table, as indicated by the 15% gain for the SPDR Dow Jones Industrials ETF (NYSE: DIA) since the end of August.

On any given day, investors and traders can point to any metric or barometer as a catalyst that moved the markets, but what the health of the U.S. economy boils down to is the consumer. In fact, the U.S. consumer still accounts for roughly 70% of the overall GDP. With the holiday season upon us, it so happens that we are currently in the midst of the most important stretch of the year for retailers. Rewinding a bit, some may recall that on black Friday, CNBC gave us an aerial look using satellite imagery at a few major shopping centers on the east coast that compared parking lot attendance to last year. The finding, of course, was that many more consumers were trekking out on the craziest shopping day of the year in search of finding “can’t miss” deals.

One product category that shoppers were particularly honing in on was consumer electronics – especially large flat screen TVs, which were slashed at big-box retailers such as Wal-Mart (NYSE: WMT) and Costco (Nasdaq: COST). As we learned last week, these deep discounts hurt Best Buy (NYSE: BBY), which didn’t participate as aggressively in its promotions, ultimately leading it to lowering its fiscal year 2011 guidance and admitting that it lost some market share in that category.

These sophisticated satellite shots of shopping mall parking lots was probably “more show than substance”, but November retail sales of +1.6% versus the +0.8% expectation confirmed the more subjective accounts that holiday shopping was strong. Not only were more people braving the crowds in 2010, but once again, online retailers such as Amazon.com (Nasdaq: AMZN) and perhaps EBay (EBAY: NYSE) figure to be winners.

It’s a bit early to pop the champagne and declare victory, but with the consumer apparently ready to open their wallets a bit more, it sure feels as if the economy is on the right track heading into 2011. With that in mind, we should be all in on the stock market, right? Well, not exactly. Thomas Kee Jr., President of Stock Traders Daily, recently wrote a column titled “An Answer For Larry Kudlow: The Investment Rate.” In it, he commented that the CNBC commentator posed the question, “What could derail the recovery now that the tax extensions have passed?” Mr. Kee’s answer to him in this column was that the Investment Rate – the most accurate leading longer term stock market and economic indicator – does not foretell of good news for investors. More details regarding the IR are provided to subscribers of Stock Traders Daily.

Outside of this observation, there are other formidable geopolitical risks on the horizon. In particular, on the Korean peninsula and across the European continent. This past weekend, North Korea threatened war on the South, which was conducting military exercises. Fortunately, this was one of the North’s frequent bluffs, but the rogue country has already proven that it will use military force. The question is, how many more ships can be sank and how many more shellings can there be before South Korea and the U.S. are forced to take action. Needless to say, this situation could escalate quickly and there isn’t an easy political answer to the problem. Complicating matters is China’s shadowy relationship with North Korea. While not exactly allies, the two countries aren’t exactly foes either. With an already fragile relationship between the U.S. and China, any disruption could put the two super powers at even greater odds, which would have vast economic implications.

Also, by no means is Europe out of the woods with its debt crisis. There is already disagreement cropping up regarding the make-up of Ireland’s bail-out, and it remains to be seen if other European countries’ (Greece, Portugal) austerity programs have any traction. These countries also face mounting geopolitical pressures due to their populations’ rage against the slashing of programs and an increasing retirement age. It won’t take long for investors and traders to feel the burn if any of the PIIG countries miss a payment on their loan packages. In recent weeks, the ProShares Ultrashort Euro (NYSE:EUO) has been trending higher, as people take bets that there may be more trouble brewing on the horizon for the region.

To summarize, there is an undeniable positive trend emerging in the U.S. economy, but the question will be whether that factor wins out against a batch of potential geopolitical risks ahead. Given that it is impossible to know how those risks will play out, one strategy is to take a hedge position in a fund such as the Proshares UltraShort ETF (NYSE: SDS). Now may be an opportune time to purchase some protection too, since shares are cheap given the bullishness in the market. Or, another route is to pick up shares of the iPath S&P 500 VIX Short-term Futures (NYSE:VXX), which is a play on expected volatility.

However, it is also in these tricky environments in which our service becomes invaluable and where our competitive advantage is most apparent. Since we don’t manage billions of dollars, we don’t need to use complicated hedging strategies. Rather, we can nimbly control risk and shift from long to short, or vice-versa, optimizing your profits. To learn more about our services, click here.

Support and Resistance Plot Chart for

Real Time Updates for Repeat Institutional Readers:

Factset: Request User/Pass

Bloomberg, Reuters, Refinitiv, Zacks, or IB users: Access Here.