Should You Short S&P 500 with ETFs This Summer?

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It seems that the S&P 500 has left its sunny days behind!

This key U.S. index last hit a record high of $2,131 on May 21, 2015, and lost about 4.3% in the last one year (as of the May 19, 2016). As a matter of fact, the index suffered corrections ( down over 10% from previous highs) during this timeframe and could not really regain its lost ground.

The hollowness of this one year becomes more prominent when you look at 45 record highs in 2013 and 53 in 2014, as per Wall Street Journal. Though the start of 2015 was equally grand with 10 highs till May 21, the journey afterward was simply lackluster.

This makes it imperative to understand investors' perception on the S&P 500 before it approaches its anniversary of highs on May 21, 2016.

What's Behind This Decline?

There are plenty of reasons. One of the main factors is the global market crash that was induced by the Chinese currency devaluation and extreme plunge in oil prices last summer. Since then China and oil have been a pain in the neck. In addition to this, earnings recession, overvaluation concerns, Fed liftoff in December and ambiguity over the Fed's next moves amid global growth issues challenged the broader market (read: Fed to Hike in June? Expected ETF Moves ).

If this was not enough, when market watchers were almost sure about a delayed policy tightening in the wake of threats to the stability of the U.S. economy, the latest Fed minutes hinted at the possibility of a June hike.  As an instant reaction, the S&P 500 fell to its lowest level since March on May 19. The reason for this fall was the fear of shrinkage in liquidity in the stock market.

Turbulent Times Ahead for S&P 500?

A volley of upbeat data released lately on retail, housing, inflation and consumer sentiments may boost the Fed's confidence that the economy can now digest an additional hike. Then again, the global market is still edgy and has all the power to derail the U.S. index if the Fed acts alongside (read: Global Growth Worries Loom: ETFs to Play ).  

In today's concept of an open economy, it is hard to bet on a large-cap stock index just on the basis of domestic market recovery. First, if the Fed strikes, the greenback will jump hurting the profitability of companies with considerable exposure in foreign lands. More than 30% of the S&P 500 revenues depend on international economies.

Plus, investors should note that IMF, while slashing global growth forecasts recently, reduced the U.S. growth forecast for 2016 too from 2.6% to 2.4% . After all, though inflation is rising, it is yet to reach the level where it can digest further hikes comfortably. In April 2016, American inflation was at 1.13%. Notably, a rise in rates lowers inflation. Also, uncertainties regarding election in November flares up risk in the S&P investing.

Earnings of the S&P 500 index are likely to decline 6.7% in the first quarter of 2016 while revenues are expected to fall 1% as per the Zacks Earnings Trends issued on May 18. Though the trend looks up from the second quarter onward with expected earnings reduction of 6% for the ongoing quarter, earnings growth of 0.4% in Q3 and again growth of 7.3% in Q4, it is less likely for  the S&P 500 to jump before late second half (read: Earnings Recession Put These ETFs in Focus ).

Analyst Bearish on S&P 500

In March 2016, Goldman commented that the index in overvalued. It recently noted that "the forward P/E multiple of the S&P 500 index ranks in the 86th percentile relative to the last 40 years. They note that the median stock in the index trades at the 99th percentile of its historical valuation on most metrics." Goldman also noted that historically the S&P 500 index is fairly range-bound until November in a presidential election year.

Bank of America believes that the S&P 500 could slip to its February lows, while Morgan Stanley has applied the famous maxim "Sell in May and go away" to stocks at least till November. All in all, no great news is expected from the S&P 500 in the coming summer.

Short via ETFs?

Going by the above thesis, the S&P 500 will likely see rough trading ahead, but investors could easily profit from this decline by going short on the index. There are a number of inverse or leveraged inverse products in the market that offer inverse (opposite) exposure to the index. Below we highlight those and some of the key differences in each:

ProShares Short S&P500 ETF ( SH )

This fund provides unleveraged inverse exposure to the daily performance of the S&P 500 index (read: 4 ETF Strategies that Deny "Sell in May and Go Away" ).

ProShares UltraShort S&P500 ETF ( SDS )

This fund seeks two times (2x) leveraged inverse exposure to the index.

ProShares UltraPro Short S&P500 ( SPXU )

Investors having a more bearish view and higher risk appetite could find SPXU interesting as the fund provides three times (3x) inverse exposure to the index. 

Direxion Daily S&P 500 Bear 3x Shares ( SPXS )

Like SPXU, this product also provides three times inverse exposure to the index.

Bottom Line

We would also like to note that the relative strength index of the S&P 500 based ETF SPY is presently 43.92. This indicates that the fund is yet to enter the oversold territory.

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PRO-SHRT S&P500 (SH): ETF Research Reports

PRO-ULSH S&P500 (SDS): ETF Research Reports

PRO-ULT SH S&P5 (SPXU): ETF Research Reports

DIRX-LC BEAR 3X (SPXS): ETF Research Reports

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Zacks Investment Research

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

This article appears in: Investing , ETFs
Referenced Symbols: SH , SDS , SPXU , SPXS

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