This is always an exciting time of the year for me. As a fan and watcher of both baseball and the markets, I find that March is a time for celebration. The markets are often finishing up a nice October-to-April rally (before the sell in May and go away crowd steps in), and the boys of summer are back in Florida and Arizona as spring training gets under way. Yet, as with the last few years, the talk of past and present steroid use has dampened the enthusiasm that surrounds the commencement of a new baseball season. As is often the case, much of this talk gravitates to a discussion of the record books, and whether recently passed milestones should be labeled with an asterisk (*) for those records broken by cheats and users of performance enhancing drugs.

As the A-Rod story recently unfolded, and the talk of steroids in baseball once again took center stage, I began to think about the similarities between both baseball and the stock market over the last 10+ years. Both, as it turns out, were aided by performance enhancers. Like baseball, the markets were on steroids, yet the market steroids were in the form of leverage, loose lending standards, poor risk management, complex derivative products, unrealistic valuations, and unethical behavior, among others. In hindsight, the problems and transgressions seem obvious, just as the increased size of Barry Bonds and Jose Canseco made us wonder why we ignored our lying eyes. Of course, the reason is clear. Watching home runs tower over the center field bleachers is fun, almost as much fun as making money. Lots of money.

Unfortunately, the fallout of a performance enhanced market will not be as painless as the one in baseball. Sure, Mike Greenwell (who finished second to Canseco in the 1988 MVP voting) or Albert Pujols (who finished second to Bonds twice in 2002 and 2003) may feel different, and the integrity of the game has been put into question, but fans can continue to consider Hank Aaron as the true all-time home run leader, regardless of what the record books say. An * next to the record, while satisfying to some fans, is not really necessary. Yet with the markets, it is not that easy, or painless. The market record books have already been corrected, and a decade of financial juicing has been wiped clean. But it is not only the fans of the market who have been duped, and lost fortunes previously made. Even those who were not active participants or watchers of the stock market game have suffered, as both 401k values and home prices have fallen. Unlike baseball, investors don't get to pick and choose whether they accept the new record. The values have been reset, but the remnants remain.

Yet America has always been forward looking, so it is natural to ask: Are there any lessons that baseball can teach the markets? Possibly, although baseball is still getting its own house in order. Nonetheless, the markets can take some cues, and begin the path to redemption. For starters, market participants will need to come to expect lower returns, just as baseball fans are less likely to see 60+ home runs in a season, or 450 foot moon shots. Generating consistently high and above average returns in stocks and home prices is not realistic. Sure, there will be an occasional Roger Maris hitting 61 dingers from time to time, or 30+ percent portfolio gains, but it will happen less frequently (although enjoyed more).

Markets will also need to be more self-aware. Consistent upper deck home runs should be a cause for concern, and not celebration. Likewise, unusual returns, aka Bernard Madoff and various other funds, need to raise a red flag. While this may come in the form of more regulation, this does not have to be the only answer, or the only course of action. Both investors and those inside the industry need to be more skeptical, and less willing to turn a blind eye.

Finally, both baseball and the stock markets (and politicians for that matter), need to focus more on solutions to the problems, and less on finding scapegoats, punishing the guilty, and using the crisis to achieve other goals. This does not mean ignoring the problem, or rewarding the guilty, but focusing only on the cheats does not engender confidence in the game. Even in the darkest hours, offering more positive solutions can go a long way towards restoring the faith in each institution. After all, baseball and capitalism are American traditions. Beating both into the ground is not good for any of us.

Now let's play ball.

As active investors continue to watch their portfolios fall, it is natural for even traditional buy-and-hold investors to not only consider liquidating existing positions, but also think about ways to hedge their portfolio (or even profit from the relentless downward trend). Since the easy short money has probably already been made, some investors and traders are turning to 2X and 3X inverse or short ETFs to juice returns. While such ETFs have been in existence for a while, and articles detailing the uses and pitfalls have surfaced (see two recent 2009 WSJ articles here and here), it is still worth reminding investors how double, triple, and inverse ETFs are better suited for day traders, and are not perfect tracking vehicles past one day. The reason for this is that with the right type of daily moves over an extended period of time, compounding errors can result in inverse ETFs generating overall losses, even when the reference index is down considerably. Tom Lauricella's WSJ article outlines why:

"For example, take a double-leveraged fund with a net asset value of $100. It tracks an index that starts at 100 and that goes up 5% one day and then falls 10% the next day. Over that two-day period, the index falls 5.5% (climbing to 105, and then falling to 94.5). While an investor might expect the fund to fall by twice as much, or 11%, over that two-day period, it actually falls further -- 12%. Here's why: On the first day, doubling the index's 5% gain pushes the fund's NAV to $110. Then, the next day, when the index falls 10%, the fund NAV drops 20%, to $88."

So while a 2X short ETF will double your daily returns when the associated index is down by X, holding periods longer than one day are subject to compounding variations. Unfortunately, such compounding effects may not be the only surprise for long-term investors of index ETFs, or even those with shorter holding periods. Investors need to fully understand what is being tracked. For instance, the popular USO ETF actually trades based on crude oil futures, and not the spot price of crude. As such, if futures prices do not increase as much as the spot price, your ETF may end up gaining less than expected. Rolling from one contract month to the next could also cause gains or losses. If the crude oil futures market is in contango (futures trading for more than spot), rolling over the futures from one month to the next could generate a large loss for the ETF, and lower gains for the investor, as new positions are purchased at a higher price [Note: for a good overview on the issues regarding the USO, see the following seekingalpha article].

As with all ETFs, make sure you look beyond the name, and have some idea how the price is set. The various 2X and 3X inverse ETFs may not be giving you the type of long-term hedge or position you are expecting, and the commodity ETFs may not be following the spot price as anticipated. Finally, always be sure that any index the ETF is following actually has the type of diversification and representation you are looking for. Some industry ETFs may be heavily weighted in just a few companies, or may be focused more on a specific sub-industry.