Lately, traders are escalating their short selling of U.S. stocks. The total U.S. short interest exceeded $1 trillion this month, even as the S&P 500 Index has risen 4.4%, indicating a belief that the index’s 14% rally in 2023 might lose steam. As bearish bets increase, so does the likelihood for inverse ETFs to gather momentum in the near term.

Be Careful About a Narrow Market

The S&P 500 index’s rally this year has been centered on Nvidia, Meta, Tesla, Apple, Alphabet, Microsoft and Amazon. So, basically, we've got a narrow market, where a few winners are driving the rally. This is scary since if these stocks get overvalued and the economy lacks strength, the market will fall.

Wall Street legend Bob Farrell's rules for investing: markets are weakest when they narrow to a handful of big names, and strongest when they are broad also suggests the fragility of the S&P 500.

Analyst Warnings About High-Profile Stocks

Short sellers already incurred paper losses of around $101 billion this year. But they are still expecting the S&P 500’s impressive 2023 rally to fizzle out. This is because of the fact that the performance of the S&P 500 wouldn’t be enthusiastic without the contribution of seven big tech companies.

Now, many of these high-profile tech stocks indicate a bearish sentiment as most of these are overbought and overvalued. Analyst warnings, such as the recent downgrade of Tesla by Barclays Plc, thus enhances the case for the inverse ETF investing.

AI-Frenzy to Fizzle?

U.S. stocks have surged in 2023 due to better-than-expected earnings and a tech rally triggered by the boom in artificial intelligence (AI). However, some analysts believe that the AI-fueled rally might soon hit a bump.

Fed to Resume Rate Hikes?

Though the Fed has paused on its rate hike momentum in June, the U.S. central bank is likely to hike rates again this year. This could trigger a market downturn. Powell's warning of higher rates confirms the potential for market instability. In such a situation, inverse ETFs could benefit.

Ripe Recessionary Threats

Goldman Sachs believes that there is a 25% chance of a U.S. recession over the next 12 months, as quoted on Bloomberg. The banks also sees a 23% downside to stocks in a recession scenario, per a Bloomberg article. The bank’s strategists also opined that investors are heavily positioned in equities, leaving less scope for new buyers to enter the market and support the rally.

Against this backdrop, below we highlight a few inverse equity ETFs that should be kept a close tab on.

ETFs in Focus

Direxion Daily Semiconductor Bear 3x Shares (SOXS Quick QuoteSOXS - Free Report) – Up 14.7% past week

MicroSectors FANG+ Index -3X Inverse Leveraged ETN (FNGD Quick QuoteFNGD - Free Report) – Up 6.4% past week

Direxion Daily S&P Biotech Bear 3x Shares (LABD Quick QuoteLABD - Free Report) – Up 4.9% past week

Direxion Daily S&P 500 High Beta Bear 3X Shares (HIBS Quick QuoteHIBS - Free Report) – Up 3.9% past week

ProShares UltraPro Short QQQ (SQQQ Quick QuoteSQQQ - Free Report) – Up 1.6% past week

ProShares UltraPro Short Russell2000 (SRTY Quick QuoteSRTY - Free Report) – Up 1.4% past week

MicroSectors U.S. Big Oil Index -3X Inverse Leveraged ETN (NRGD Quick QuoteNRGD - Free Report) – Up 1.3% past week

ProShares UltraPro Short MidCap400 (SMDD Quick QuoteSMDD - Free Report) – Up 0.1% past week

Direxion Daily S&P 500 Bear 3X Shares (SPXS Quick QuoteSPXS - Free Report) – Down 0.5% past week