ETF Trends
ETF Trends

The recent pullback in the equities market has some investors spooked. Traders who are anticipating further pain can hedge against turns with inverse exchange traded funds that capitalize on the market’s misfortunes.

For instance, the recent stumble revealed that growth stocks were among the most vulnerable areas of the markets. Consequently, traders can hedge against any weakness with the ProShares Short QQQ ETF (NYSEArca: PSQ), which takes the inverse or -100% daily performance of the Nasdaq-100 Index. [Inverse ETFs to Hedge a Pullback in the Nasdaq]

For the aggressive trader, the ProShares UltraShort QQQ ETF (NYSEArca: QID) tracks the double inverse or -200% performance of the Nasdaq-100, and the ProShares UltraPro Short QQQ ETF (NasdaqGM: SQQQ) reflects the triple inverse or -300% of the Nasdaq-100.

Indicators are flashing warning signs that the equities markets are overbought after an extended bull run, reports Anora Mahmudova for MarketWatch.

The Office of Financial Research, which promotes financial stability and monitors the markets, recently stated that the stock market is dangerously overpriced and the excessive leverage will cause greater swings in the next market correction.

“In light of this interest rate backdrop, the question is whether stock prices have run too far ahead of fundamentals,” Ted Berg, an analyst at OFR, said in a report. “Although certain traditional valuation metrics, such as the market’s forward PE ratio, do not appear alarmingly high relative to historical averages, other metrics to be discussed — the cyclically adjusted PE ratio (“CAPE”), the Q-ratio, and the Buffett Indicator — are nearing extreme levels, defined as two standard deviations (or two-sigma) above historical means.”

At the end of 2014, the CAPE ratio, a valuation measure based on real-per-share earnings over a 10-year period, was in the 94th percentile of historical levels. The Q-Ratio, the market value of non-financial corporate equities divided by net worth, is also moving toward its two-sigma deviation – the last time it crossed the level, it quickly plunged following the crash. Lastly, the Buffett Indicator, a ratio of corporate market value to gross national product, is at its highest since 2000. [Inverse ETFs to Hedge a Bearish ‘Warren Buffett Indicator’]

Consequently, Berg warns of a large market price decline after a period of extreme valuations. Specifically, Berg points out that the market indicators are two-sigma above historical means, which typically occurs once every 40-plus years, but they occur more often in equity markets due to fat-tail distributions.

For more information on the markets, visit our current affairs category.

Max Chen contributed to this article.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.