Best ETFs for when the bubble bursts

With markets overbought and fundamental indicators pointing to a slowdown, now could be a good time to consider protecting current positions or making a directional bet.

By MoneyShow.com May 14, 2013 1:58PM

Stock market copyright Digital Vision Ltd., SuperStockBy John Nyaradi, Wall Street Sector Selector


As this year's impressive rally continues, U.S. stock indexes and exchange-traded funds (ETFs) are either on track for historic annual gains or reaching bubble levels with the growing possibility of an approaching blow-off top.


At Wednesday's closing bell, the S&P 500 (SPY) and its related ETF were 157 points (or almost 11%) above its 200-day moving average. The only time we have seen a wider gap between the S&P's 200-day MA and its closing level was back in March of 2000, just before the dot-com crash. Will history repeat itself or only rhyme?


The stock indices cannot keep going up forever (contrary to what you may have been told by your favorite television stock market commentator). At this point, multiple technical indicators are flashing warnings that markets are overbought and subject to a significant correction.


Beyond the fact that the S&P 500 is closing at extreme levels above its 50-day and 200-day moving averages, its relative strength index is also near overbought conditions, which begins at the threshold of 70.


At Wednesday's close, the S&P's RSI had reached 68.58 -- although after Thursday's retreat, the RSI had eased back to 65.54. Investors respond to these signals, which often make many stock market indicators self-fulfilling prophecies as other investors change their positions based on what they see on current charts.



chart
Chart courtesy of StockCharts.com
Click to Enlarge


With the major stock indices at their current levels, investors remain concerned about the consequences of a blow-off top and so many have their stops set high to preserve the maximum extent of the extreme gains they have realized so far. If the stock market swoons, multiple stops will get triggered and a cascade of stop loss orders can quickly lead to a waterfall descent in today's world of high frequency, computer-driven trading.


Overbought conditions exist across all of the U.S. major stock market indexes and so the entire U.S. market is subject to a swift correction should one get underway.


At Wednesday's closing level of 15,082.62, the Dow Jones Industrial Average was 1,437 points or 10.5% above its 200-day moving average. The Russell 2000 closed at 966.26 on Wednesday, which is 101 points or 11.68% above its 200-day moving average. The Financial Select Sector SPDR ETF (XLF) closed on Wednesday at $19.17, 15.97% above its 200-day moving average.


Such conditions have set the stage for many institutions and hedge funds to try to front run an anticipated decline by taking short positions in futures contracts, shorting stocks, or taking positions on inverse ETFs, which are designed to gain in value should the stock market swoon in June.


Some examples of inverse ETFs include:

ProShares Short S&P 500 ETF (SH): This ETF is designed to obtain results, which represent the inverse (-1x) of the daily performance of the S&P 500. The fund invests in derivatives, which ProShares Advisors believes should have similar daily return characteristics as the inverse of the daily return of the S&P 500.


ProShares Short Dow30 ETF (DOG): This ETF is designed to obtain results, which represent the inverse (-1x) of the daily performance of the Dow Jones Industrial Average. The fund invests in derivatives, which ProShares Advisors believes should have similar daily return characteristics as the inverse of the daily return of the Dow Jones Industrial Average.


Investors with a greater appetite for risk (and return) can use leveraged inverse ETFs, by which their gains (or losses) will be magnified by approximately twice as much as a non-leveraged inverse ETF.


One of the most popular of these is ProShares Short Dow30 ETF (DXD). This ETF is designed to obtain results, which represent two times the inverse (-2x) of the daily performance of the Dow Jones Industrial Average. The fund invests in derivatives, which ProShares Advisors believes should have similar daily return characteristics as two times the inverse (-2x) of the daily return of the Dow Jones Industrial Average.


For the truly daring, there are some leveraged inverse ETFs, which will magnify the results by three times. Two of the largest of these focus on the small-cap and financial sectors, which tend to be fast movers in falling markets:


Direxion Daily Small Cap Bear 3x Shares (TZA): This ETF is designed to obtain results, which represent 300% of the inverse of the Russell 2000 Index. The fund creates short positions by investing at least 80% of its assets in financial instruments, which provide leveraged and unleveraged exposure to the index.


Direxion Daily Financial Bear 3x Shares (FAZ): This ETF is designed to obtain results, which represent 300% of the inverse of the Russell 1000 Financial Services Index. The fund, under normal circumstances, creates short positions by investing at least 80% of its assets in financial instruments, which provide leveraged and unleveraged exposure to the Russell 1000 Financial Services Index.


Bottom line: With markets overbought and fundamental indicators pointing to a global economic slowdown, now could be a good time to consider protecting current positions or making a directional bet with inverse ETFs. These products, particularly the leveraged class, can be tricky to use, so make sure to read the prospectuses carefully and understand how they work. 


Take time to plan your strategy for a summer swoon because there's a good chance that significant opportunities will appear on the "short" side of the market as we head into the "sell in May and go away" period of the year.


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3Comments
avatar

Quote

Not as long as this Wall Street patsy, Bernanke, is still bending over. It's that simple. he's creating what the FED was designed to STOP.....BUBBLES. He's the biggest fool not seen since the likes of someone like Palin.

End Quote

Not true the FED was designed to steal money from ordinary Americans by taxing the US government by issuing interest based debt. The interest is the tax on the government.

 

However they were too successful and have taxed the US government into bankruptcy.

 

 

May 15, 2013 11:02AM
avatar

JERRY MAC;You never cracked a book in your life and yet you know more than Bernanke.

Amazing.Don`t be bitter, just because you missed 100% increase in the market the last

4 years.1% in CD`S is a great way to go.Denny`s is a good restaurant for you.

May 15, 2013 8:47AM
avatar
Not as long as this Wall Street patsy, Bernanke, is still bending over. It's that simple. he's creating what the FED was designed to STOP.....BUBBLES. He's the biggest fool not seen since the likes of someone like Palin.
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