The S&P 500 has rallied approximately 5% in the first four weeks of the New Year and is sitting near a multi-month high. The index is up roughly 20% from the recent low set on Oct. 1, 2011. This is a sign that stocks are back into an official bull market. Everything seems to be pointing to a trend that will probably continue for a few months. (For related reading, see Digging Deeper Into Bull And Bear Markets.)
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However, the major indices are overbought and there is a high probability of a pullback heading into February. It would not be unhealthy if the S&P 500 were to incur a 5% sell-off that would bring the index back to its breakout area and at the same time, keep the uptrend intact.
Whether you are a bull and believe in higher prices in a few months or a bear that believes the current rally is over and a new downtrend is around the corner, there are a few ETFs that should benefit from weakness in the overall market.
An ETF that will simply give investors the inverse of the S&P 500 on a daily basis is not a bad way to protect a portfolio or profit from selling. The ProShares Short S&P 500 (ARCA:SH) does just that for an expense ratio of 0.9% annually. Keep in mind that due to compounding the returns for SH over time, they may not match the exact return of the inverse of the S&P 500 over the same time frame. Most inverse or leveraged ETFs are better used for short-term trades or hedging.
The Market Vectors Double Short Euro (ARCA:DRR) is a two-times leveraged inverse ETN that will rise 2% in value on a day that the euro falls by 1% and vice versa. Over the last few months, whenever the stock market has fallen, it has been related to issues in Europe that also bring down the currency. For example, when the S&P 500 fell close to 20% from early May through late September last year, DRR was up almost 20%. The ETN creates a hedge against trouble in Europe. (To learn more, read A Beginner's Guide To Hedging.)
The United States Short Oil Fund (ARCA:DNO) seeks to offer its investors in percentage terms the inverse return on the spot price of light sweet crude. If a pullback occurs, it will likely be brought on by news of a global economic slowdown and therefore it will lower the price of oil and push DNO higher. During the near 20% sell-off in the S&P 500 last year (as mentioned above), DNO gained approximately 40% and was a great hedge.
The Vanguard Intermediate Term Bond (ARCA:BIV) is a mix of government-issued and investment grade corporate bonds. The average maturity is 7.3 years and it has a 30-day SEC yield of roughly 2.29%. The yield is not overly attractive, but as money flows out of equities the ETF should attract money and at the very least hold steady and preserve capital during a sell-off. During the near 20% market sell-off last year, the ETF was up more than 5%, not including the monthly dividends.
The Bottom Line
As I mentioned above, if you are a bull on this current market, the pullback will likely be short and sweet if you are right. On the flipside, if the bears are right, the selling will likely last a few months and have a much bigger downside. The bears could buy the ETFs mentioned, then hold and wait for the pullback. The bulls that consider the ETFs must be nimble and time the market, which can be very difficult for the average investor. (For additional reading, see 3 Steps To A Profitable ETF Portfolio.)
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At the time of writing, Matthew McCall did not own shares in any of the companies mentioned in this article.