Bearish ETF Strategies for a Pessimistic Outlook

After a punishing first half of the year for the stock markets, traders continued to ramp up bets against equities. Exchange traded fund investors can also hedge against further market risks with bearish or inverse strategies.

According to JPMorgan Chase & Co.’s analysis of futures tracking major stock indexes, asset managers and hedge funds raised bets against U.S. stocks to the highest level since 2016 on fears over a global slowdown, the Wall Street Journal reported.

Additionally, according to a survey by the National Association of Active Investment Managers, the average active investor pared back stock exposure this year and reduced equity allocations to the lowest levels since the start of the COVID-19 pandemic.

“Everybody’s focused on recession risk,” Parag Thatte, a strategist at Deutsche Bank, told the WSJ.

Adding to bets of a recession, the bond market’s recession indicator, an inverted yield curve, recently reached its widest level in two decades — the majority of past recessions were preceded by an inverted yield curve or when yields on later-dated bonds dip below yields of short-term debt.

Meanwhile, many market observers have raised bets that the Federal Reserve will hike interest rates by a full percentage point at the next meeting, something that hasn’t happened in decades, which further added to the belief that policymakers would drag the economy into a slowdown.

According to Deutsche Bank estimates, investors have now steadily diminished their exposure to stocks to some of the lowest levels of the past 12 years. In addition, bullish bets in the options market among traders slipped to the lowest level since April 2020.

“We’ve now determined that it’s better to be slightly short rather than long,” Martin Bergin, president at Dunn Capital Management, told the WSJ. “If there’s a bounce, we’ll start to take on more long exposure.”

ETF traders who are looking to protect their portfolios from potential pullbacks ahead may consider some exposure to bearish or inverse ETFs to hedge against further falls.

For example, the ProShares Short S&P500 (SH) takes a simple inverse or -100% daily performance of the S&P 500 index. Alternatively, for the more aggressive trader, leveraged options include the ProShares UltraShort S&P500 ETF (SDS), which tries to reflect -2x or -200% of the daily performance of the S&P 500, the Direxion Daily S&P 500 Bear 3x Shares (SPXS), which takes -3x or -300% of the daily performance of the S&P 500, and the ProShares UltraPro Short S&P 500 ETF (SPXU), which also takes -300% of the daily performance of the S&P 500.

Those who want to hedge against risk in the Dow Jones Industrial Average can use inverse ETFs to bolster their long equities positions. The ProShares Short Dow 30 ETF (DOG) tries to reflect -100% of the daily performance of the Dow Jones Industrial Average. For more aggressive traders, the ProShares UltraShort Dow 30 ETF (DXD) takes the -200% of the Dow Jones, and the ProShares UltraPro Short Dow 30 (SDOW) reflects the -300% of the Dow.

Lastly, investors can also hedge against a dipping Nasdaq through bearish options as well. For instance, the ProShares Short QQQ ETF (PSQ) takes the inverse or -100% daily performance of the Nasdaq-100 Index. For the aggressive trader, the ProShares UltraShort QQQ ETF (QID) tracks the double inverse or -200% performance of the Nasdaq-100, and the ProShares UltraPro Short QQQ ETF (SQQQ) reflects the triple inverse or -300% of the Nasdaq-100.

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