The major United States stock indexes are now around 5% from the multi-year highs set earlier this year, and it may be time to consider investments that rise as the overall market falls. Investors have the option of shorting individual stocks and profiting from their fall in price. However, this type of strategy is limited to certain account types and it is out of the risk scale of most individual investors.
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Other than stocks there is the option of exchange-traded funds (ETFs) as a way to profit from market weakness or at a minimum hedge a portfolio that has a net long position in stocks.
The typical short ETF will attempt to return the inverse of the underlying index it follows. For example, the ProShares Short S&P 500 ETF (ARCA:SH) will return the inverse of the daily move in the S&P 500. The keyword is daily because if the ETF is held for one year and the S&P 500 is down 10%, do not expect the ETF to be up 10%. The fact it is reset daily will result in returns that do not directly correspond to the long-term return of the underlying index. Since the S&P 500 topped out on Apr. 2, 2012 the ETF is up about 4%.
Active Short ETF
The AdvisorShares Active Bear ETF (ARCA:HDGE) seeks capital appreciation through short sales of domestic equity securities. The bottoms up approach searches for companies that have low earnings quality and uses aggressive accounting methods. The managers also look for stocks that have downward earnings revisions or reduced guidance.
The one major issue I have with the HDGE ETF is the high fees. The management fee is 1.5% and the short interest expense is 1.44%; the total net expense ratio is a staggering 3.29%. That being said, it may be worth the fees considering the ETF is up over 13% since Apr. 2, 2012. The current largest short positions in the ETF are Goodyear Tire (NYSE:GT), Deutsche Bank (NYSE:DB) and Citigroup (NYSE:C).
SEE: Advantages And Disadvantages Of ETFs
The PowerShares U.S. Dollar Index Bullish ETF (ARCA:UUP) has been a consistent hedge for investors looking to find alternative investments that do well when the market falls. Since Apr. 2, 2012, UUP is up around 1.5% and has put together a seven-session winning streak as money leaves the euro and other higher-risk currencies. The reason UUP moves inverse to the stock market recently has been the view of the greenback being a safe haven currency that investors will buy when fear levels increase. The ETF charges an expense ratio of 0.80%.
The VIX Short-Term Futures ETF (ARCA:VIXY) seeks to provide investment results that match the performance of the S&P 500 VIX Short-Term Futures Index. The CBOE Volatility Index (VIX) measures the volatility of the S&P 500 and as prices fall the value of the VIX will typically rise. Therefore a drop in the value of the stock market would be beneficial to VIXY. Since April 2, VIXY has risen by nearly 6%. Investors must expect volatility with investing in VIXY and it is only for investors that are able to take on risk. The expense ratio is 0.85%.
SEE: Introducing The VIX Options
The Bottom Line
The fact the S&P 500 is roughly 5% from a multi-year high is not a signal to the end of the bull market. It may be the beginning of a longer-term pullback or it could simply be the normal pullback that all indexes have during a long-term bull market. Keep in mind that if the market begins to resume the uptrend that the four ETFs mentioned above will likely fall in value.
At the time of writing, Matthew McCall did not own shares in any of the companies mentioned in this article.