SSO: Patience Was Rewarded

Summary

  • The market selloff has hit SSO hard, as this is a leveraged fund that is long the S&P 500 (2x).
  • After getting cautious on this investment in April, I now see value where it did not exist before.
  • Steep intra-year declines like the one we are experiencing now are a common occurrence. Typically, buying-in results in calendar year gains.
  • Stock prices are declining faster than earnings revisions. This makes the S&P 500 look a lot cheaper than it has been in a while.
  • This idea was discussed in more depth with members of my private investing community, CEF/ETF Income Laboratory. Learn More »
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Main Thesis & Background

The purpose of this article is to discuss the ProShares Ultra S&P500 (NYSEARCA:SSO) as an investment option at its current market price. This is a fund I follow closely, but buy selectively, because it is a leveraged ETF that can be highly volatile. Specifically, it is designed to offer a "return that is 2x the return of its underlying benchmark for a single day, as measured from one NAV calculation to the next". This benchmark is the S&P 500, so SSO is the right move for those expecting large-cap U.S. equities to rise.

On this backdrop, it should not be surprising I turned cautious on this fund back in April. Equities were startling to get rattled, and elevated share prices to me suggested downside was on the horizon. In hindsight, it was smart to get cautious, but I should have been more bearish as the S&P 500 saw a sharp drop since then, punishing SSO as a result:

Fund Performance

Fund Performance (Seeking Alpha)

Given this sharp sell-off in equities, I wanted to take another look at SSO to see if I should initiate a position again, or if I should hold off because more pain is on the way. After review, I believe this correction represents a reasonable buying opportunity, and I will explain why in detail below.

Sharp Declines Are Not Rare

To level-set early, I want to emphasize that I am feeling skittish about the market just like most investors probably are. I will admit I have seen my portfolio decline by the start of the year - it would be difficult to not be in this position! In uncertain times like this, with war in Europe, a continuing pandemic, and rapid inflation, it can make investing seem all the more challenging. Therefore, I will say I do not suggest investors take on more risk than they can manage at this juncture. Personally, I see a positive bounce coming in the near-term, but I can very well be wrong. If investors are already leveraged / fully invested, then taking on more equity positions may not be the right move, even if one has a bullish outlook. The tide can turn quickly, as we have seen lately, so investors need to make sure they stay within their risk tolerance and don't over-extend themselves.

Yet, for investors who have some cash or who can withstand more volatility, I see sharp corrections as buying opportunities. As I mentioned, I faded my position in SSO after a nice gain and headline risks began to worry me. After this sell-off, I see merit to getting back in. Part of the reason why is that although sharp intra-year drops can be painful when they occur, we should recognize they are not all that uncommon. In fact, most calendar years seen drops in excess of 10% for the S&P, and sometimes much more than that:

S&P 500 Returns

S&P 500 Returns (JPMorgan Asset Management)

This gives me two key takeaways. One, what we are witnessing now is not a phenomenon, but a rather natural occurrence. Two, as the graphic above illustrates, even when the S&P 500 sees a steep correction, the index often registers a positive return for the year. This is important, as it shows quite clearly that investors are rewarded for staying invested over the longer term, even when there are big moves in both directions.

My thought here is this is exactly why I want to build a position in SSO again. The S&P 500 is down, but history shows us that buying during big drops will be rewarded. To amplify those potential rewards, a leveraged fund like SSO will be a higher risk - higher reward play. While I would not suggest buying in to SSO every time the S&P 500 sees a 1% or 2% drop, after it hits correction territory, I simply can't resist the urge to buy in. The history of the index supports my outlook that this will be a profitable move.

Share Prices Dropping Faster Than Earnings

My next top rests with valuation. This is another important indicator I track before considered a leveraged fund like SSO. When 2022 began, stocks were nowhere near "cheap", but investors had limited options with expectations of a continued global recovery and low interest rates. Now, with that recovery in some doubt and interest rates on the rise, investors are beginning to look at fixed-income and cash in a more positive light. This pressures the attractiveness of equities. The end result is this has contributed to the decline in the major indices, which can initiate a downward spiral.

Fortunately, there is a silver lining to this environment. This is that buying in to the S&P 500 index now is cheaper than it has been in a while. In fact, the forward P/E has dropped below 18 for the first time in five years, as seen below:

S&P 500 Forward P/E

S&P 500 Forward P/E (FactSet)

Of course, there are valid reasons for this decline. Seeing a P/E drop is not an automatic buy signal. The market has been justifiably pressured. Inflation is a major headwind, interest rates are going up too slow to combat it, and supply-chain worries persist. So, all is not necessarily well. But I take comfort in knowing that investors are being better compensated for navigating these risks. With the forward P/E in decline, that means the premium equity investors must pay has begun to reflect this challenging macro-environment. This makes me more comfortable holding on to a bullish fund like SSO, as I believe a reversion to the mean is probably going to happen. If it does, share prices will rise, and SSO along with them.

Are There Risks? Of Course. Inflation Is One

At this point I want to moderate the bullishness of this article. I do see equity corrections and declining P/Es as reasons to be bullish. So, I do stand firm on my "buy" call at these levels and I do expect stocks to rebound. But this is just a prediction. There is absolutely a chance equities continue lower and, if they do, SSO is going to get punished. So, readers need to acknowledge that going in and not get too carried away with positions.

The reasons here are multi-fold, but one of the biggest ones is inflation. This has been the boogeyman for a while, although it has taken the last few quarters before government officials have finally gotten the message. Inflation has been rampant for a while, and this is challenging consumer spending, business sentiment, and premiums for growth stocks. The last point there is key, because the S&P 500 is heavily exposed to the Tech sector and some major growth names. When inflation goes up and Fed rate hiking becomes more apparent, investors are less willing to pay up for growth names because those names imply returns will materialize in the future (rather than now). The more inflation eats away at present dollar spending power, the more prone investors are to invest in products that have strong cash flow now. This can include bonds, consumer staples, utilities, or other more defensive plays. For perspective, readers should note SSO mimics the S&P 500 in this top-heavy weighting towards Tech:

Fund Holdings

Fund Holdings (ProShares)

So, why is this a problem now? The answer is because inflation remains as an important a topic now as it was 3, 6, and 12 months ago - if not more so. Recent readings show inflation is still red hot, although there are signs it may be "peaking". While that would be encouraging, we are still a long way from a normalized price environment, which is challenging for consumers, businesses, and stocks as a whole:

Inflation Metrics

Inflation Metrics (Yahoo Finance)

The importance here cannot be overstated. Inflation is starting to put a dent in consumer spending. This in and of itself can cause growth to slow, as consumer purchasing power declines. Further, the Fed's action to hike interest rates will also cool growth, as it makes borrowing and debt more expensive. While this is "good" in the sense it will help normalize inflation, too much of a slowdown can be bad for stocks. In fact, markets are already beginning to increase the odds of a recession in the near-term, which is another factor influencing the dramatic decline in share prices:

Recession Probability

Recession Probability (Bloomberg)

This is not meant to be alarmist. In fact, buying equities during recessions can often lead to strong gains. But buying in before recessions often results in losses. This is a delicate balance right now. While equity markets selling-off suggests buying the dip is the right move, if the odds of a recession keep going up it is very likely equities will find it difficult to move higher.

The conclusion here is again some moderate optimism. In fairness, odds of a recession near 30% means the chances are stronger we won't see a recession in the next 12 months. That's the good news. The bad news is this number is ticking up as the year goes on, so readers need to evaluate their own outlook on the chances of this occurring, their current risk tolerance, and their personal exposure to growth names already. Depending on the balance of those factors, one can then decide if a fund like SSO is a holding that makes sense in this environment.

I Like The Health Care Exposure

My final take is on the Health Care sector - which readers may have noticed is SSO's second largest sector by weighting. This is an area that I have been optimistic on for a long time, and that sentiment continues today.

While the pandemic is still ongoing and I don't want to minimize the emotional, mental, and physical toll it is still having on those impacted, it is fair to say that conditions have improved significantly. Cases are down, deaths are declining (per day), and vaccines are widely available. As we continue to return to normal in the sense of a resumption of pre-pandemic activities, I believe the outlook for Health Care as a whole is strong. This is because the pandemic has forced patients to cut back on more elective procedures and treatments due to an unwillingness to go to medical facilities and/or an inability of care providers to offer those services (potentially due to space or staff constraints). Therefore, I expect 2022 and 2023 to see a return in demand for elective procedures, drug sales, and medical equipment that are more lucrative to providers bottom-lines. This is a positive for the sector.

On a more longer-term view, we should continue to understand that demographics trends favor this sector. The U.S., and the world, are getting older and emerging markets are experiencing an increase in their middle-class make-up. This means more people are going to need, and be able to afford, care, and that is good for humanity as well as Health Care service providers.

Bottom-line

The market's sell-off is simply an opportunity for bulls to put some cash to work. SSO is a way to capitalize on this drop and generate alpha if markets do recover. While risks remain, I believe we will see a near-term bounce as valuations have declined and inflation is showing signs of peaking. SSO is a good option for those who can withstand some additional risk, and actively make short-term moves. As a result, I am once again long SSO, and I suggest readers give this ETF some consideration at this time.

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This article was written by

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7.74K Followers
CEF/ETF income and arbitrage strategies, 8%+ portfolio yields

Macro-focused investor, working for a major U.S. bank. I grew up in New York, but escaped to North Carolina. I was a D1 athlete in college (men's tennis) and compete competitively to this day. My Bachelor's and MBA are both in Finance.

I provide reasoned, fact-based analysis of different funds and sectors. I list my portfolio here so readers can gain insight into what I am buying/holding, what I'm not, and how that lines up with the views I present in my articles. 

Broad market: VOO; QQQ; DIA, RSP

Sectors: VPU / BUI; VDE / UCO; KBWB; XRT

Non-US: EWC; EWU; EIRL; EWA

Dividends: DGRO; SDY, SCHD

Municipals/Debt Funds: NEA, BBN, PDO, BGT

Stocks: WMT, JPM, MAA, SWBI, MCD, DG, WM

Cash position: 25%

Disclosure: I/we have a beneficial long position in the shares of VOO, SSO either through stock ownership, options, or other derivatives. 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.

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