First, inventory levels remain elevated and are likely to trend upward.To add to the inventory woes, foreclosures are expected to flood the market. From a lending perspective, mortgage rates have been driven down by the Fed’s decision to keep interest rates at exceptionally low levels. These favorable rates are generally only available to those who have hefty down payments and high credit scores. To make things even worse, an optimistic economic assessment released by the Federal Reserve yesterday failed to repeat its assertion that the housing market is improving. Additionally, it appears that the extension of the $8,000 first-time homebuyer tax credit didn’t give the sector the boost that was so strongly desired. Lastly, from a macroeconomic perspective, existing-home sales will likely feel downward price pressures.

Some ETFs that should keep these forces in mind include:
The SPDR S&P Homebuilders(XHB Quote)
The iShares Dow Jones US Home Construction(ITB Quote)
The iShares Dow Jones US Real Estate(IYR Quote)

These ETFs have seen a nice upward trend over the past year, but this could come to an end. To help mitigate the risks involved with investing in them, it’s important to use an exit strategy with triggers at price points that represent abnormal price weaknesses.

Foreign bonds are considered riskier than domestic bonds because of the unavoidable uncertainty due to exchange rate risk and country risk. The same is true for foreign and domestic common stocks. Such investments as art, antiques, coins, and stamps require heavy liquidity risk premiums. You should divide consideration of real estate investments between your personal home, on which you do not expect as high a return
because of nonmonetary factors, and commercial real estate, which requires a much higher rate of return due to cash flow uncertainty and illiquidity.

Studies on the historical rates of return for investment alternatives (including bonds, commodities, real estate, foreign securities, and art and antiques) point toward two generalizations.

1. A positive relationship typically holds between the rate of return earned on an asset and the variability of its historical rate of    return. This is expected in a world of risk-averse investors who require higher rates of return to compensate for more uncertainty.

2. The correlation among rates of return for selected alternative investments is typically quite low, especially for U.S. and foreign stocks and bonds and between these financial assets and real assets, as represented by art, antiques, and real estate. This confirms the advantage of diversification among investments from around the world.

In addition to make many direct investments, such as stocks and bonds, we also could use investment companies that allow investors to buy investments indirectly. These can be important to investors who want to take advantage of professional management but also want instant diversification with a limited amount of funds. With $10,000, you may not be able to buy many individual stocks or bonds, but you could acquire shares in a mutual fund, which would give you a share of a diversified portfolio that might contain 100 to 150 different U.S. and international stocks or bonds.

Canadian interest rate expectations have risen sharply following improvements in the labor market and a rise in consumer prices. The central bank is expected to remain on hold until mid-2010 but we could see them act aggressively if inflation becomes an issue. Governor Carney in a recent interview stated that their remains considerable slack in the economy and is sticking to the commitment to keep rates low. However, the central bank leader would go on to say that there are signs of stabilization in the labor market and that the housing sector is seeing strength.

U.S. interest expectations have started to stabilize as weaker than expected personal income and spending figures have tempered the outlook for future tightening. Nevertheless, the improvement in both areas reaffirms a recovery is underway which should keep the central bank on track to raise rates sometime in the second half of 2010.

The Origins of IPO ETFs

The First Trust IPOX-100 (NYSE:FPX) was the first available IPO ETF, launching in early 2006. The IPOX-100 reflects the performance of the 100 largest IPOs, which gives investors the opportunity to benefit from those companies’ successes. The attraction to investing in a company at its IPO is that the investor can get in on the ground floor of a newer company with high-growth potential.

IPOX: Not All-Inclusive

However, the IPOX Index has specific stipulations that would prohibit it from including IPOs like that of Chipotle. The IPOX Composite does not include companies with a more-than-50% gain on the first day of trading; this was put in place to avoid those securities which were thinly traded or overly volatile.

The index also excludes issuing companies for a variety of other reasons. Only United States corporations are accepted, and a number of investment vehicles are excluded such as: real estate investment trusts, close-ended funds, American depositary receipts from non-U.S. companies and American depositary receipts from foreign companies, as well as unit investment trusts and limited partners.

Companies that meet the requirements for the IPOX Composite also need to have a market capitalization of $50 million or more. Additionally, the initial public offering must provide at least 15% of total outstanding shares. Another way in which the IPOX-100 Index Fund does not allow for enormous first-day gains to be included within the portfolio is through only investing in securities after they have already been on the market for a period of seven days. In addition to having to be publicly traded for this period, securities are removed from the fund on their 1,000th day of trading, which means that the index could suffer when a major performer is removed.

Rules of the Fund

IPO ETFs are especially vulnerable to economic declines, which is evident, as the credit crisis limiting the financing capabilities for new companies. The IPO index that the IPOX-100 ETF follows struggles to perform during difficult economic periods. Also, the vulnerability to a single major company in the index illustrates the inherent danger in IPO ETFs.

Another timing-based rule the fund has in place is that companies are added or removed from the index on a quarterly basis, which could potentially limit the IPOX-100 ETF’s returns.

The problems for IPO ETFs

Some critics charge that investing in an IPO ETF is risky. The risk of investing in companies that are going public is often associated with the “dotcom bubble” of start-up companies. In recent years, underwriters seem to have adjusted to more accurate pricing for IPOs, and thus the IPO index has been more stable and predictable. Another potential problem for IPO ETFs is that the IPO companies, usually relatively small corporations, will be more prone to failing in a down market than well-established companies.

All in all, IPO ETFs are becoming more reliable and stable as the market becomes more comfortable with them. when evaluating IPO ETFs, we need to remember that they invest and divest on a quarterly basis and  have a seven-day purchasing and 1,000 day selling rule.

Institutional investors could use them to quickly enter into and exit positions, making them a valuable tool in situations where cash needed to be raised quickly. While individual investors have little recourse when liquidity decreases, institutional investors who use ETFs may avoid some liquidity issues through buying or selling creation units, which are baskets of the underlying shares which make up each ETF. Large brokerage houses such as Morgan Stanley and Salomon Smith Barney also occasionally act as authorized participants when a client makes a large order. Based on their ability to purchase the underlying stocks in the ETF, they can create a huge number of ETF shares instantly with little difficulty in a liquid index like the S&P 500.

Not surprisingly, ETFs based on indexes that also have derivatives tied to them have even slimmer bid-ask spreads. The reason is that there is heightened interaction between the specialists, market makers, and arbitrageurs. In other words, ETF shareholders benefit from this increased competition because it narrows spreads. More firms are researching ETF bid-ask spreads, and the results confirm that ETFs tied to liquid indexes have very small spreads.

However, if you have confidence in U.S. market liquidity then you should feel safe using existing broad-based domestic ETFs, and their history thus far bears that out. We would add that a wait-and-see attitude could be beneficial for potential ETFs tied to illiquid indexes – private securities or municipal bonds, for example.

Factors That Influence ETF Liquidity

It remains true that ETFs have greater liquidity than mutual funds. Some investors appear to believe that the liquidity of an ETF is dependent on the fund’s average trading volume, or the number of shares traded per day. However, this is not the case. Rather, a better measure of ETF liquidity is the liquidity of the underlying stocks in the index. Although ETFs trade like stocks, trading volume does not give good insight into how easily they trade, because the underlying securities make the difference. Below are some factors that affect the liquidity of ETFs.

Underlying Asset: ETFs which have less liquid equities as there underlying assets are usually less liquid than those have liquid equities as underlying asset.

Diversification: ETFs which invest in broad diversified market indexes are usually more liquid than which invest in specific sectors.

Market Capitalization: ETFs which invest in large-cap stocks are usually more liquid than mid-cap and small-cap tracking ETFs.

Fixed Income Securities: ETFs which have fixed income securities like treasury bonds, corporate bonds, etc as underlying instruments are more volatile and is also less risky.

Economy: ETFs which track indexes of emerging world economies are usually considered less liquid than that of developed world economies. Also ETFs investing in domestic securities are more liquid than foreign ones.

Trade Volume: Although not a major factor, increase in trading volume of ETF positively contributes to the liquidity of it.

Trading volume of underlying stocks: The more the underlying stocks are traded the higher the liquidity of ETF.

Time, News and Market Forces: These ever changing factors affect the liquidity of all the traded instruments including ETFs.

Choose Carefully

Investors trying to gauge which ETFs are cheapest and easiest to trade need to keep two factors in mind: how frequently the stocks or bonds that make up the ETF trade, and how frequently the ETF itself trades.The efficiency of an ETF depends on the efficiency of the underlying stocks. A fund that owns a giant auto maker will typically trade more smoothly than one made up of its tiny, thinly traded parts supplies. But it’s also important to weigh the trading volume of individual ETFs, since heavy volume benefits small investors.

Keep a Close Watch

There’s a wealth of information available to make sure an ETF is on track before you trade.

First, check whether an ETF’s market price is close to the value of its holdings, known as its net asset value, or NAV. ETFs have a special mechanism that creates and redeems fund shares in line with investor demand. The mechanism is supposed to all but eliminate premiums and discounts relative to NAV, and it works well — but it’s not perfect.

Investors can see an ETF’s premium-and-discount track record on the Web site of the fund company that offers it. The SEC requires firms to publish graphics showing the number of days each ETF closed at a significant distance from its NAV. But these graphs give only a broad historical picture, and they’re usually updated only once a quarter, so recent problems may not have shown up yet.

To make sure an ETF is trading accurately when investors actually want to buy, they need to find its indicative intraday value, or IIV, an estimate of NAV that ETFs publish every 15 seconds throughout the day. There’s a separate ticker symbol for the portfolio’s IIV which investors can punch in and compare to the fund’s trading.

The other number investors need to check is the bid-ask spread. At a penny, the spread on SPDR is just 0.01% of the recent price of a SPDR share. But recently, fear and uncertainty have driven spreads on dozens of ETFs above 0.5%. And a handful have reached above 5%. While investors should see an ETF’s current trading spread on their brokerage firm’s Web site before placing an online order, getting historical spreads can be difficult. Unlike premiums and discounts, spread information isn’t usually available on fund-company Web sites.

Tricks of the Trade

There is no guarantee every trade will receive flawless treatment. Trading problems can affect even the most experienced investors.

One frequently cited solution is to use “limit” rather than “market” orders. Limit orders instruct brokers to buy shares only if they can find them at or below a given price, not at whatever price the market offers.

Investors making large purchases also might consider breaking their orders up into small chunks to ensure all the shares receive quoted prices. Bid-ask quotes usually apply only to a few hundred shares, so with large orders, significant swaths can get filled at less-attractive prices.

Time of day can also matter. Bid-ask spreads tend to be significantly wider in the minutes after the markets open than they are midday. That’s because market makers are unsure how to value ETFs before the funds’ underlying holdings have started recording prices.

Still, nothing works all the time. If prices are moving fast, strategies like limit orders or waiting for a calmer market also can lead to missed opportunities.

The conception of Leveraged ETFs

Leveraged ETFs are exchange-traded funds that are based upon well-known indexes, but that provide investors with additional leverage by using borrowed money. Their goal is to increase the return of the underlying index and provide a better return for the fund’s investors. Typically they provide $1 of debt for every $1 of investor equity, and are marketed as 2X funds.

The problems of Leveraged ETFs

One problem of leveraged ETFs  is that many investors misunderstand how leveraged ETFS work.  A widely held misconception about these funds is that they will offer twice the return of the underlying index, which means that if the S&P 500 returns about 10% a year, then the SSO should return 20%. But that’s not true, because these funds only double the daily return, and there’s a big difference between doubling the daily return and doubling the annual return.  Let’s say that one day the market goes up 10%, and the next day it falls 10%. The two-day loss for the index is 1%, but the loss for the leveraged fund is 4%. Here’s why:

Index: (1 + 10% ) x (1 – 10%) = 1.1 x 0.9 = 0.99, 1% loss
X2 Fund: (1 + 20%) x (1 – 20%) = 1.2 x 0.8 = 0.96, 4% loss

Thus over a two day period, this fund’s losses are 4x the amount of the index, not 2x. This example comes from the ProShares prospectus, and is a clear indication that investors in 2X funds should not expect their investment to provide double the return of the S&P 500 for any period longer than one day.

In addition, the folks running these leveraged funds must constantly buy and sell shares of the underlying index, or futures contracts and other derivatives, to keep their leverage ratios in line. This buying and selling activity increases the underlying volatility, and can lead to huge sell-offs in down markets that are impossible to recover from in the next bull market. Moreover, the turnover increases expenses and transaction costs, eroding investors’ ultimate returns.

ETFs are the ideal tool for the investor focused on asset allocation. They represent just about every asset class available and are cheap, liquid, and reliable. The primary asset classes in which ETFs are available include:Large Cap Stocks, Mid Cap Stocks, Small Cap Stocks, Growth Stocks,Value Stocks, Sector Stocks, International Stocks, Country, Emerging Market Stocks, Long-term Bonds, Mid-term Bonds, Short-term Bonds and Real Estate Investment Trusts. These and other asset class categories may be used together to obtain finer-grained asset classes. Thus small value stocks are an asset class in their own right, and ETFs are being created every month around these subclasses. Only investable, publicly traded companies are represented, and private firms are excluded.

An ETF that contains investments in different asset classes allows an investor to buy one ETF and get a fully diversified portfolio.  Indeed, one of the greatest benefits of ETF investing is the cost structure. All things being equal, the lower one’s investing costs, the higher one’s investment returns.  ETFs are the right vehicle for accessing stocks, bonds, currencies, commodities and real estate at the lowest cost costs possible.

For starters, ETFs offer one the ability to manage downside risk. And since risk is measured on the downside — risk being defined as the possibility of loss — one must actively protect against excessive losses. This is very easy to do with ETFs and individual stocks… simply by using trailing stop-loss orders.

Examples of asset allocation ETFs include: PowerShares Autonomic Balanced NFA Global Asset Portfolio (AMEX:PCA),  PowerShares Autonomic Balanced Growth NFA Global Asset Portfolio (AMEX:PTO)