As the Federal Reserve begins to aggressively tighten its monetary policy and potentially trigger a recession in the process, wary investors could turn to alternative or bearish exchange traded fund strategies to hedge the potential downside risks.
According to Bank of America strategists, the macro-economic picture is deteriorating at a rapid clip and could cause the U.S. economy to dip into a recession as the Fed hikes interest rates and cuts down its balance sheets to tame surging inflationary pressures, Reuters reports.
“‘Inflation shock’ worsening, ‘rates shock’ just beginning, ‘recession shock’ coming”, BofA chief investment strategist Michael Hartnett said in a note to clients.
Deutsche Bank also mirrored the sentiment, pointing to the sudden aggressive shift in the Fed’s stance.
“We no longer see the Fed achieving a soft landing,” Deutsche Bank economists led by Matthew Luzzetti said in an analyst note, according to Fox Business. “Instead, we anticipate that a more aggressive tightening of monetary policy will push the economy into a recession.”
The Federal Reserve indicated Wednesday that it could start cutting down assets from its $9 trillion balance sheet at its upcoming meeting in early May and could do so at almost twice the pace of its previous “quantitative tightening” exercise in a bid to contain inflation running at a four-decade high.
Many market participants are also bracing for the Fed to hike interest rates by 50 basis points.
ETF traders who are looking to protect their portfolios from potential pullbacks ahead may consider some exposure to bearish or inverse ETFs to hedge against further falls.
For example, the ProShares Short S&P500 (NYSEArca: SH) takes a simple inverse or -100% daily performance of the S&P 500 index. Alternatively, for the more aggressive trader, leveraged options include the ProShares UltraShort S&P500 ETF (NYSEArca: SDS), which tries to reflect -2x or -200% of the daily performance of the S&P 500, the Direxion Daily S&P 500 Bear 3x Shares (NYSEArca: SPXS), which takes -3x or -300% of the daily performance of the S&P 500, and the ProShares UltraPro Short S&P 500 ETF (NYSEArca: SPXU), which also takes -300% of the daily performance of the S&P 500.
Those who want to hedge against risk in the Dow Jones Industrial Average can use inverse ETFs to bolster their long equities positions. The ProShares Short Dow 30 ETF (NYSEArca: DOG) tries to reflect -100% of the daily performance of the Dow Jones Industrial Average. For more aggressive traders, the ProShares UltraShort Dow 30 ETF (NYSEArca: DXD) takes the -200% of the Dow Jones, and the ProShares UltraPro Short Dow 30 (NYSEArca: SDOW) reflects the -300% of the Dow.
Lastly, investors can also hedge against a dipping Nasdaq through bearish options as well. For instance, the ProShares Short QQQ ETF (NYSEArca: PSQ) takes the inverse or -100% daily performance of the Nasdaq-100 Index. 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.
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