The stock market has been doing well lately. Some investors consider this a good reason to expect a drop or temporary bear market. When everyone thinks stocks are on their way up, enthusiasm can lead to values that are unrealistic.
Any seasoned investor knows that the conviction that stocks won’t go down is dangerous. The market is said to climb a wall of worry. Prices climb when there are people who think they won’t. This balance of selling pressure and buying enthusiasm keeps the market in balance and avoids an “overbought” condition.
If you want to play a market correction or pullback, you will need to short stocks. One of the best ways to do this is with reverse equity exchange-traded funds (ETFs), or inverse ETFs. An inverse exchange-traded fund (ETF) makes money when stocks go down in price. If the index the fund follows goes down 1%, the inverse ETF goes up 1%. Money managers achieve this by “shorting” the stocks on the index. (See also: Inverse ETFs Can Lift A Falling Portfolio.)
Inverse ETFs bet against the market and prosper when stock prices fall. (See also: Indexing Beats Active Management in a Bear Market.)
We have selected four ETFs for a bear market that are designed to short the market and make you money when stocks fall. The selections were made based on total assets. We did not select year-to-date yield as our criteria because the market has been rising, and inverse ETFs would not be expected to have much of a yield in that situation.
You can put these ETFs on a watch list, and if you see signs of trouble in the marketplace, you will be ready to jump in and take advantage of a decline. All figures are current as of February 14, 2017.
1. ProShares Short S&P 500 (SH)
SH uses the S&P 500 as its benchmark. It aims to match the performance of that index if it starts going down. It does this by investing in derivatives. This can include futures contracts, swaps and stock options. The fund focuses on the behavior of large-cap stocks but also watches real estate investment trusts (REITS). Keep in mind that an investment in this fund will lose money if stock prices go up. This is a fund for the short term when you think you see a temporary decline in the market about to happen.
- Avg. Volume: 1,894,811
- Net Assets: $1.74 billion
- Yield: 0.00%
- YTD Return: -1.78%
- Expense Ratio (net): 0.89%
- Inception Date: June 19, 2006
- Since Inception: -10.36%
2. ProShares UltraShort S&P 500 (SDS)
This is an aggressive fund that tries to achieve two times the inverse of the S&P 500. The large-cap focus and the aim of 2x the inverse of the index makes SDS a higher-risk ETF than SH (listed above).
This fund if for those who have strong conviction that the market is going to drop. You would be expecting to make twice as much as SH. You would also be taking on twice the risk. This fund uses derivatives to achieve its goals. This is not a long-term play. Note the negative returns for the year and since inception. Investors use a fund like this to take advantage of negative market momentum and then get out when the market turns upward again.
- Avg. Volume: 7,085,124
- Net Assets: $1.69 billion
- Yield: 0.00%
- YTD Return: -3.51%
- Expense Ratio (net): 0.90%
- Inception Date: July 11, 2006
- Since Inception: -22.83%
3. ProShares UltraPro Short S&P 500 (SPXU)
This is the most aggressive fund on our list. It aims to achieve three times the inverse of the performance of the S&P 500. SPXU offers the highest returns of the three ETFs on our list, and it carries the highest risk. If the market turns against you, you could start losing money fast. If you get into this inverse ETF, be prepared to watch it daily and stay abreast of any news affecting the broader market. SPXU has lost more than 44% since inception.You would use this fund to make money fast and get out at the first sign of a market recovery.
- Avg. Volume: 3,836,540
- Net Assets: $735.87 million
- Yield: 0.00%
- YTD Return: -5.10%
- Expense Ratio (net): 0.91%
- Inception Date: June 23, 2009
- Since Inception: -44.28%
4. ProShares Short Russell2000 (RWM)
This ETF is tied to the Russell 2000. You would use this ETF if you expected small-cap stocks on the Russell index to decline in price. The fund uses derivatives. RWM is a good example of how you can invest in a way that only shorts one type of stock, while remaining “long” in stocks from another index.
- Avg. Volume: 631,898
- Net Assets: $310.06 million
- Yield: 0.00%
- YTD Return: -0.41%
- Expense Ratio (net): 0.95%
- Inception Date: January 23, 2007
- Since Inception: -13.42%
The Bottom Line
A true bear market can last a long time. Given the current condition of the market, you are more likely to take advantage of temporary pullbacks or perhaps a correction. You can make money in these downtrends by using ETFs that follow a broad index.
3 out of 4 of our ETFs on this list follow the S&P 500. This means you would be expecting the market in general to turn negative. There is a lot of optimism in the market right now, and a contrarian could argue that optimism is the precursor to pessimism. If the market goes down, these bear market ETFs will be poised to take advantage.