Ultrashort ETFs Feeling the Pain

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Includes: SKF, TWM
by: TraderMark

I finally started culling some of the ETF shorts on Tuesday - the pain was getting too great. Monday was the worst day in the fund in terms of being outperformed by the indexes. Lost 2 full points to the Russell 2000 Monday since the fund was hedged with these short positions.... and hedged in the parts of the market that are now (finally) rallying - the small caps and the financials.

Those have been laggards and up to now had not participated much in the market rally post Fed rate cut, so didn't hurt the fund much. But Monday and Tuesday they were strong, and just really killed performance.So either we are going into a period of full blown participation where the small caps and laggards (home builders, financials) join the strong areas, or we are near to the end of this rally as the junk (stuff that should not be going up) goes up, and bears run for cover.

I don't which it is, but like Roberto Duran said (or did he?) "No Mas". I still retain them as a hedge to some degree, but I lowered my UltraShort Russell 2000 (NYSEARCA:TWM) down to 3.9% of the fund and the UltraShort Financials (NYSEARCA:SKF) down to 3.0%. I am hoping this pain I am feeling is akin to 'throwing in the towel' and the market actually pulls back.

The problem is everyone is sitting here waiting for a 'pullback' so they can participate - so even the very minor pullback was met with massive buying. So I view this selling Tuesday in the short ETFs perhaps as parallel to selling long positions in mid-August at the heights of the pain for bulls. I hope by offering this sacrifice the market gods will look down kindly and bring the market down some.

But too many people are wanting to load up on pullbacks, so it seems too crowded of a trade. So this leaves 2 more probable scenarios: a huge move forward or a significant decline. I am eager to see how the market treats Friday's job report - if this "all news is good news" (as Doug Kass likes to say) continues - than it seems fruitless to have hedges on. Only when everyone else short throws in the towel and says "No Mas" will the market finally give up the ghost.

I've given up at least 2% of performance with these hedges. That stinks. Unlike shorting individual names, shorting an index is a much trickier proposition (more bludgeon less scalpel) so they are not quite so effective as saying "this restaurant stock stinks, I want to short it". Ironically the fund's two worst days in terms of trailing the market indexes were the day of the cut and Tuesday, the two strongest days where "everything goes up".

You don't want to be hedged at all in markets like that. As for Friday's employment report, I believe last month's number of 4k losses will be revised up quite significantly and then September's number will be below consensus but not as bad as last month's. Maybe a 50-70K positive (I think consensus is around 100K). If that is good or bad is pretty useless from an investing perspective - it's all about the market's reaction to this number.

One man's guess anyhow. I think Q3 earnings will be "good" but guidance in most domestic facing companies will be "worst than expected" offset by "better than expected" guidance by companies not directly facing the US consumer. But none of that matters right now with the flood of money (in part from central bankers) hitting equities. Ben, no mas.

Long UltraShort Russell 2000 and UltraShort Financials in fund