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Inverse Equity ETFs to Bet on Historic Selloff

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The bull run in U.S. stocks has finally been shaken after almost nine years. The second-largest and most-powerful rally was caught off guard at the start of this month.

This is especially true as the selloff in major bourses deepened with the start of the new week as they suffered their worst drop in more than six years and eroded all the gains made in 2018.

In fact, the bloodbath led to the biggest one-day decline for the Dow Jones Industrial Average in its 122-year history when the index was down nearly 1,500 at one stage. However, the blue-chip index recovered slightly at the close, slumping 1,175 points or 4.6% while the S&P 500 plunged 4.1%. With this big slide, both indexes turned negative for the year.

The rout started on Friday, leading Wall Street to its worst weekly performance in two years, pushing the Dow Jones and the S&P 500 down nearly 4%. Rising U.S. bond yields after the better-than-expected wage growth triggered the selloff. Average hourly wages rose 0.3%, pushing the year-over-year increase to 2.9% — the fastest pace in more than eight years. The strong number has sparked fears of inflation and the resultant speculation of faster-than-expected rate hikes (read: Wall Street Sees Worst Selloff in Years: 5 ETF Buying Zones).

The Fed intends to increase interest rates three times this year but the rise in inflation could lead to four hikes or even more this year. Higher rates would make the stocks less attractive compared to other investments, particularly bonds, which offers higher yields. In anticipation of aggressive rate hikes, the 10-year Treasury yield jumped to as much as 2.88%, marking a four-year high.

Further, political turmoil including a government-funding deadline on Feb 8 and upcoming debt limit issue, new leadership at the Fed with Jerome H. Powell as well as threats of overvaluation have added to the woes.

The stock rout does not end here as the Dow futures are signaling further decline in today’s trading session. Dow futures slumped more than 350 points, or 1.5% at the time of writing, in pre-market trading today, suggesting that the turmoil will deepen. The vicious selloff on Wall Street has left the stock market on the verge of a "correction,” which means a 10% drop from the recent highs. The Dow Jones is currently down 8.5% from its previous closing high, while the S&P 500 is off 7.8%. The Nasdaq has tumbled 7.2% from its all-time high (read: 6 ETFs for a Historically Soft February).

In the ongoing chaos, investors could easily tap the opportunity by going short on U.S. equities at least for the near term. There are a number of inverse or leveraged inverse products in the market that offer inverse (opposite) exposure to the three major bourses. Investors should trade them cautiously, keeping their risk appetite in mind. Below we highlighted them and the key differences between each:

S&P 500 Index

For investors seeking to bet against the S&P 500 index,ProShares Short S&P500 ETF (SH - Free Report) andDirexion Daily S&P 500 Bear 1X Shares (SPDN - Free Report) are good choices. These provide unleveraged inverse exposure to the daily performance of the S&P 500 index. SH is a popular and liquid option with AUM of $1.3 billion and average daily volume of more than 2.2 million shares. Both gained 4% over the past week.

ProShares UltraShort S&P500 ETF (SDS - Free Report) seeks two times (2x) inverse exposure to the index while ProShares UltraPro Short S&P500 (SPXU - Free Report) and Direxion Daily S&P 500 Bear 3x Shares (SPXS - Free Report) provide three times (3x) inverse exposure. Out of the three, SDS is relatively popular and liquid, having amassed nearly $937.1 million in AUM and 3.6 million shares in average daily volume. It is up 15.2% over the past week while SPXU and SPXS have surged 23.6% each.

Dow Jones

To bet against Dow Jones, ProShares Short Dow30 (DOG - Free Report) , ProShares UltraShort Dow30 (DXD - Free Report) and ProShares UltraPro Short Dow30 (SDOW - Free Report) are the three options in the market. DOG offers unleveraged exposure to the index with AUM of $247.5 million and average daily volume of 586,000 shares. It has gained 8.4% over the past week. On the other hand, DXD provides two times inverse exposure while SDOW seeks three times exposure. Both ETFs were up 17.2% and 25.7%, respectively (read: Unbelievable ETFs & Stocks On Sale).

Nasdaq-100 Index

Similarly, ProShares Short QQQ (PSQ - Free Report) provides unleveraged inverse exposure to the daily performance of the Nasdaq-100 Index. ProShares UltraShort QQQ (QID - Free Report) seeks two times (2x) while ProShares UltraPro Short QQQ (SQQQ - Free Report) provides three times (3x) inverse exposure to the index. These funds have gained 7.3%, 14.7% and 22.6%, respectively.

Bottom Line

While the strategy is highly beneficial for short-term traders, it could lead to huge losses compared with traditional funds in fluctuating or seesaw markets. Further, their performances could vary significantly from the actual performance of their underlying index over a longer period when compared with the shorter period (such as, weeks or months) due to their compounding effect (see: all Leveraged Equity ETFs here).

Still, for ETF investors who are bearish on equities for the near term, either of the above products could make an interesting choice. Clearly, these could be intriguing for those with high-risk tolerance and a belief that the “trend is the friend” in this specific corner of the investing world.

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