While U.S. equities enjoyed a strong rebound on Tuesday, short or bearish interest remains and financial strategists warned that more declines are likely with investors too complacent about the possibility of a recession. Meanwhile, traders could turn to inverse exchange traded fund strategies to hedge against further market pullbacks.
Societe Generale SA’s Manish Kabra warned that a “typical” recession could see the S&P 500 Index falling to 3,200 points or nearly 13% below its Friday close before the holiday, Bloomberg reported.
Furthermore, Societe Generale SA strategists projected that a 1970’s style inflation shock could cause the benchmark to plunge 30% from current levels amid selling from stagnation with higher inflation or a so-called stagflation scenario.
“We have still not seen the true bottom for equities yet,” Kabra said.
Michael J. Wilson at Morgan Stanley also believed that the S&P 500 needs to decline another 15% to 20% to about 3,000 points before the market to fully price in an economic contraction.
“The bear market will not be over until recession arrives or the risk of one is extinguished,” according to the Morgan Stanley team.
The smart money has been betting against U.S. equities. Hedge funds tracked by Goldman Sachs Group Inc. raised bearish wagers, with the dollar amount of short sales touching the highest level since the 2008 financial crisis, Bloomberg reported. Similar trends were also registered by Morgan Stanley and JPMorgan Chase & Co.’s clients.
“Managers increased micro and macro hedges amid the sharp market drawdown,” Goldman analysts, including Vincent Lin, said in a note. “With the sole exception of staples, all sectors saw increased shorting.”
David Rosenberg, chief economist and strategist at Rosenberg Research & Associates Inc., warned that it is still too early to give the all-clear signal.
“Short covering gives equities a big boost,” Rosenberg told Bloomberg. “This move should be viewed in the context of an overall downtrend – meaning rallies can be rented but not owned.”
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 (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 (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 (SPXS), which takes -3x or -300% of the daily performance of the S&P 500; and the ProShares UltraPro Short S&P 500 ETF (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 (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 (DXD) takes the -200% of the Dow Jones, and the ProShares UltraPro Short Dow 30 (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 (PSQ) takes the inverse or -100% daily performance of the Nasdaq-100 Index. For the aggressive trader, the ProShares UltraShort QQQ ETF (QID) tracks the double inverse or -200% performance of the Nasdaq-100, and the ProShares UltraPro Short QQQ ETF (SQQQ) reflects the triple inverse or -300% of the Nasdaq-100.
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