Black Monday should be a great day for short ETFs

Posted on 24 January 2010 with no comments from readers

In Britain the fourth Monday of January is semi-officially known as the most depressing of the year, a combination of bad weather and the distance from Christmas perhaps. But this year that Monday is also shaping up to be a major downer on Wall Street.

The newspapers that were cautiously bullish at the start of 2010 seem to have changed sides. The bearish news includes serious doubts about the Chinese economy, President Obama’s plans to reform the banking sector, and the solvency of Greece.

Moreover, the first three weeks of January have seen all major financial markets, bar Japan, close lower, and the odds on a fourth week of gloom therefore look very good.

Reality check x3

Underlying the pessimism is a new realism about the state of the global economy. It suffered real damage last year – the worst depression in output and trade since the 1930s – and the recovery is seen as marginal at best, and entirely driven by the rally on Wall Street at worst.

The risk is now that the rally that went to far reverses and compounds to the downside. In more normal times a short correction would be healthy. The problem is that coming after last year these are not normal times, and something more extraordinary could well follow, like a plunge to new market lows.

Certainly the triple negatives cited in the newspapers press from each side of the globe. The Greek situation is destabilizing for Europe, and highlights similar debt issues in Spain, Portugal, Ireland and the biggest per capita national debtor of all, the UK.

A realization that the Chinese dragon is running on hot air and threatened by inflation also threatens its overblown stock and housing markets, with serious implications for the global financial system.

Then again President Obama’s worthy commitment to reforming the US banking system both challenges the legitimacy of a major player in global financial markets at a difficult moment, and in promising to change the rules of the game leaves an uncertain future for bank profits.

Now putting this all together investors could be forgiven for thinking Monday looks exceptionally bleak. It does. But come the hour cometh the asset class to make hay while the sun is not shining.

Short ETFs

Short ETFs have become progressively less and less popular with investors as their values have collapsed in the recent market rally. The geared nature of these relatively new instruments has accelerated the downside. Valuation collapses of 25-fold are seen at the extremes.

Yet Black Monday will be the finest hour for short ETFs which do now have the capacity to compound at similar rates to the upside – even if not to quite such a rate as their recent decline.

The aggressive shorts are the x3 bear market ETFs, and should deliver the best performance on Monday, both for bank stocks (click here) and for Chinese stocks (click here).

For once it can be quite clearly stated that the higher risk is staying long with existing stock market holdings, and that these short ETF funds will have their moment of glory. Of course, nothing lasts forever and a ban on shorting will surely follow, but it will probably not be quick enough to stop these ETFs from profiting from a big market sell-down.