Despite the amazing run stocks have had, it really must be pointed out that for the most part, this really has been predominately fueled by the actions of the Federal Reserve. We can debate the long-term effects of its actions in another forum; it is beyond the scope of this article. Now although the market powers higher, the reality is that market moving data of the last few months has been weak, at best. This past week reported retail sales disappointed, diminishing hopes of any positive signs of growth from shoppers. It was a 50% miss, coming in at 0.2 versus 0.4 consensus growth versus the last period. The import price index was projected to increase by 0.5 from the last report and stayed flat, a 100% miss, while wholesale inventories missed by 67%, coming in a 0.1 change versus 0.3 expected. Consumer credit reported on Monday for July 2013 missed by 15.5%, coming in at a change of 10.4 versus 12.3 expected. To cap it all off, the August jobs number showed 169,000 jobs added versus 179,000 consensus, a 5.5% miss. Unemployment dipped to 7.3% from 7.4% but we all know that number is completely unreliable now. It only is going down because people are giving up looking for work. And now the prospect of the Fed 'pixie-dust' being taken away is upon is, and could send markets reeling.
The Fed could decide to taper as early as its meeting next week. There has been heated debate over this possibility. Some believe they won't taper at all this year, that things are too fragile. Others believe the hole has been dug so deep it doesn't really matter what happens, the dollar is on a path to being worthless. Others believe that the Fed could even step up its buying. I actually believe the Fed will begin to taper this year. That seems to be the consensus. Much of the Fed, including Ben Bernanke, has expressed concerns over the return on investment of continued asset purchases. Thus, I suspect the Fed will taper, as early as this week, but certainly by year end. Furthermore, I hypothesize that although most expect tapering to occur, markets will react, perhaps violently, to the downside. When the inevitable correction starts, it could happen sharply over the course of a few weeks. Thus, traders may want to put on some bearish positions to protect or even continue to grow capital. Those who are bearish could consider selling stock, selling covered calls on their positions, shorting stocks, buying puts or investing in a volatility or bear fund. While each of these approaches has its respective benefits and risks, in this article, I want to highlight three leveraged quick-pick ETF funds that could provide great short-term returns in the event of a market sell-off. A few that I recommend are:
ProShares UltraShort S&P 500 (NYSEARCA:SDS): For those with a risk appetite seeking to make a leveraged bet to the downside, consider a potentially profitable position in SDS. This leveraged fund seeks daily investment results that correspond to twice the inverse of the daily performance of the S&P 500. The management team of the SDS invests in common stock issued by public companies. The management team of SDS also invests in certain derivatives of the market to leverage to the downside.
This ETF recently underwent a one-for-four reverse split to bolster the share price, as the nearly four-year bull market took its toll on this fund's value. The value of shares not only depreciated from being sold down with other bearish plays during the bull market, but was also hurt by its expense ratio (0.89%) and the fact that it is adjusted daily. Funds that seek daily performance never track the long-term performance of an underlying index due to a concept known as "slippage." More on the concept of slippage, which I recommend most investors be aware of, can be found here.
Despite the effect slippage can have, daily leveraged funds such as the SDS, in periods of panic and bearishness, perform exceptionally well. Thus, a well-timed position can be very profitable. The SDS currently trades at $36.43 a share. SDS has an average daily volume of 10.5 million shares exchanging hands. The SDS has a 52-week range of $35.85-$61.86.
Direxion Daily S&P 500 Bear 3x ETF (NYSEARCA:SPXS): For those individuals reading this article with the highest appetite for risk (aside from investors who are willing to short stocks) the SPXS can be considered for heavily leveraged bearish exposure to large cap stocks. SPXS, formerly the Direxion Daily Large Cap Bear 3X fund, seeks daily investment results before fees and expenses of 300% of the inverse of the price performance of the S&P 500 Index. As with other funds, there is no guarantee the fund will meet its stated investment objective and is subject to slippage as described above. The fund also has a higher 1.14% annual expense ratio.
The SPXS management team likes to create short positions by investing at least 80% of its net assets in: futures contracts; options on securities, indices and futures contracts; equity caps, collars and floors; swap agreements; forward contracts; short positions; reverse repurchase agreements; ETFs; and other financial instruments that, in combination, provide leveraged and unleveraged exposure to the S&P 500. Given this approach, in times of market sell-offs, the SPXS will deliver outsized returns. Thus, this fund should be considered by those who seek to profit from panic that could result from a fast sell-off that jolts the market. Like other leveraged bear funds during this time of market exuberance, SPXS recently underwent its own reverse split.
SPXS currently trades at $45.58 a share. SPXS has average daily volume of 3.1 million shares exchanging hands. SPXS has a 52-week trading range of $44.65-$103.30
Direxion Daily Small Cap Bear 3X Shares (NYSEARCA:TZA): This is my favorite way to invest in a bear market short term. It is also of the highest risk category, given its leveraged nature. TZA management seeks daily investment results of 300% of the inverse of the price performance of the Russell 2000 Index that tracks small cap stocks. It includes approximately 2,000 of the smallest securities based on a combination of their market cap and current index membership. TZA actually does not invest in equity securities or stocks. What TZA does is creates short positions by investing at least 80% of its net assets in financial instruments to provide leveraged and unleveraged exposure to the small cap index and the remainder in money market instruments. TZA also recently underwent a reverse split in response to the bull market powering ever higher. It now currently trades at $24.20 a share on average daily volume of 11.8 million shares. TZA has a 52-week range of $23.93-$76.60.
Key Messages: The Fed is going to pull back, and the market reaction could be ugly. When the inevitable correction begins, there are many approaches investors can take to position accordingly for the market panic that will ensue. While we have had a great bull run in the last few months and the last few years as a whole, the market data simply does not support this market going higher. In fact, it probably would be heading south without all of the continued Fed intervention. I suspect markets will indeed drop soon on fundamental news. For those who are brave, shorting the SPY (NYSEARCA:SPY) or DIA (NYSEARCA:DIA) is an option. I have taken on these short positions Buying put options or selling calls on the SPY and DIA is another option for those believing the sell-off is coming. Finally, allocating some funds to the aforementioned bearish funds is an option, as they will perform very well and yield short-term gains in response to the market panic the Fed's exit will likely trigger.
Disclosure: I am long TZA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I am short DIA and SPY