S&P 500 To Dive Ahead? Short With These 5 ETFs

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Includes: SDS, SH, SPDN, SPXS, SPXU
by: Zacks Funds

The month of July was astounding for the S&P 500, which hit all-time highs on several occasions. This key U.S. equity gauge in fact advanced about 3.9% in the last one month (as of August 1, 2016). This ascent came despite a whirlpool of worries - especially the yet-to-be-seen impact of Brexit - loitering around (read: Top ETF Stories of July).

Some solid U.S. economic readings, signs of slowly abating earnings recession and relatively better banking earnings despite low levels of yields favored risk-on sentiments.

Also, analysts like Goldman believe that rock-bottom yields at various parts of the developed world spurred this stock rally. Plus, hints of a more accommodative monetary policy from foreign economies led investors to bet on key U.S. equity indices.

But will this rally last long? A group of analysts don't think so.

Inside Analysts' View

Goldman Sachs lowered the outlook on equities to 'underweight' over three months and held a 'neutral' outlook over a one-year frame. As per the research house, equities are overvalued at the current stage given the earnings recession, global macroeconomic doldrums especially in Europe, worries over the viability of stimulus-fed growth in China and last but not the least sudden geopolitical shocks.

In a recent note, Deutsche Bank's David Bianco also indicated that "the next move for the S&P 500 is a 5% to 9% decline ahead of the election." Though the U.S. economy is taking root lately, the momentum is still sluggish.

The same is the opinion of Jeffrey Gundlach, the chief executive of DoubleLine Capital. He also sees a puffiness in stock valuation as U.S. economic growth is still tepid and corporate earnings are far from steady. In fact, the Fed has already pointed to an overvaluation in U.S. stocks.

With U.S. GDP data for the second quarter coming at 1.2% versus 2.6% expected, all these warnings in fact do make sense. Gundlach prefers to stick to the safe-haven goldand his equity preference is for gold mining stocks (read: Will Mixed Earnings Take Shine off Gold Mining ETFs?).

P/E Expansion Too High to Remain Stable?

Goldman's chief equity strategist David Kostin indicated a few days back that "since September 2011, S&P 500 forward P/E has grown by 75% (from 10x to 18x)". This gigantic expansion rate was breached only twice since 1976, once in the 1984-1987 period when P/E increased 111% and then in the 1994-1999 timeframe when P/E skyrocketed 115%.

But both times, the rally ended in massive crashes. The first instance was the Black Monday collapse and the second was the tech bubble burst. So, the analyst feels it will be difficult for the S&P 500 to continue with its stellar show against the current investing backdrop.

Other Factors That May Push S&P 500 Down

Investors should note that the recent rally in the key U.S. indices was largely backed by signs of recovery in oil prices. But with oil again slipping to the $40-level on higher OPEC production and a rise in the number of rigs operating in U.S. oil fields for five successive weeks, tension started building up.

As the bull story has started to vanish from the oil patch, key U.S. gauges are likely to drift lower. Another concern is the likelihood of a Fed rate hike. Goldman sees 65% chance of a 2016 hike. Of this, 45% chance is of a December hike and 20% of a September increase.

If the Fed acts on economic bullishness, the gradual ceases in cheap dollar inflows will stymie the equity rally. And if not, then also a lackluster economy and weak corporates will go against the stock market revival.

Inverse ETFs to Gain

If you believe that the market will lose momentum ahead, you can play this warning by shorting the S&P 500 index and investing in inverse ETFs. Below, we highlight those and some of the key differences between each:

ProShares Short S&P 500 ETF (NYSEARCA:SH)

This fund provides unleveraged inverse exposure to the daily performance of the S&P 500 index. It is the most popular ETF in the inverse equity space with AUM of nearly $2.57 billion.

Direxion Daily S&P 500 Bear 1x Shares ETF (NYSEARCA:SPDN)

The fund seeks daily investment results of 100% of the opposite of the performance of the S&P 500 Index. It has amassed about $42.5 million in assets.

ProShares UltraShort S&P 500 ETF (NYSEARCA:SDS)

This fund seeks two times (2x) leveraged inverse exposure to the index. It is also a relatively popular ETF, having amassed $2.12 billion in AUM.

ProShares UltraPro Short S&P 500 ETF (NYSEARCA:SPXU)

Investors having a more bearish view and a higher risk appetite could find SPXU interesting as the fund provides three times (3x) inverse exposure to the index. It has amassed $868.1 million in its asset base so far.

Direxion Daily S&P 500 Bear 3x Shares ETF (NYSEARCA:SPXS)

Like SPXU, this product also provides three times inverse exposure to the index. It has AUM of $496.9 million.

Bottom Line

As a word of caution, investors should note that such products are suitable only for short-term traders as these are rebalanced on a daily basis. Still, for ETF investors who are bearish on the equity market for the near term, either of the above products could make an intriguing choice.

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