I’m no perma-bear and generally an optimist when it comes to stocks, but even I’m starting to get a bit worried about how long the markets can keep this up. We’ve had nearly eight years worth of steadily increases, with the S&P 500 gaining more than 250% since the recession. And over that time stocks and the funds that hold them have only gotten more and more expensive.
Today, the exchange-traded funds (ETFs) tracking the benchmark index — like the SPDR S&P 500 ETF (NYSEARCA:SPY) — can now be had for a high CAPE ratio of over 30.
The only other times CAPE has been that high has been the Great Depression, the Dotcom Bust and the Great Recession. Given history, a correction will happen eventually. The odds just keep getting moving in that event’s favor.
So investors need to be prepared.
Luckily, several ETFs allow investors to profit in the wake of a nasty correction and get through relatively unscathed. With that, here are of the best ETFs to buy in case a correction hits.
ETFs to Buy In Case of a Correction: ProShares Short S&P 500 ETF (SH)
Expense Ratio: 0.89%, or $89 per $10,000 invested.
If the correction hits, stocks are going to fall. It really is as simple as that. So shorting stocks and index options can be a great way to profit or hedge losses in a bear market. After all, you’ll make money as prices for these assets fall.
However, for most investors, the idea of opening a margin account and dealing with options sounds too risky. And that’s where inverse ETFs like the ProShares Short S&P 500 (ETF) (NYSEARCA:SH) come in.
SH seeks to provide a return opposite of the S&P 500 for a single day. Basically, if the S&P 500 loses 1% one day, SH should return 1%.
Now the key to inverse ETFs is the word “day.” Due to daily rebalancing and compounding over time, those returns can look less and less like an exact opposite of the S&P 500. But if stocks start to freefall, inverse ETFs like SH will gain.
Another benefit to using inverse ETFs like SH rather than physically shorting stocks is that you’re only risking the capital you invest. When you short, your losses aren’t capped — stocks theoretically can go up forever. The worst this fund can do is go to zero.
For investors, when the correction hits, ETFs like SH make it easy to profit for the downturn and protect your portfolio.
ETFs to Buy In Case of a Correction: PowerShares S&P 500 Downside Hedged ETF (PHDG)
Expense Ratio: 0.4%
The problem with predicting bear markets is that no one can really guess it 100% right. Even with a high CAPE, stocks could still rise further — and they did before the Dotcom meltdown. So the best course of action for investors may be to hedge themselves a little bit now while keeping at least one foot in the markets.
The PowerShares S&P 500 Downside Hedged ETF (NYSEARCA:PHDG) could be one of the best ETFs offering this exposure.
The fund tracks the S&P 500 Dynamic VEQTOR Index. While that’s a mouthful, it’s designed to provide positive total returns regardless of market direction. To do this, PHDG uses various quantitative screens to shift its assets among equities, volatility futures and cash.
Currently, the fund is allocated 90% to equities in the S&P 500 and 10% toward volatility futures.
The idea is that this mix of cash, VIX futures and exposure to the S&P 500 is dynamic and based on certain triggers. As the market sours, it’ll shift its portfolio to more VIX and cash elements. This provides a nice hedge when the correction hits. And as the markets keep rising, investors in PHDG will profit from the stock exposure.
For investors looking to take the guesswork out of timing the correction, the fund is a great portfolio choice. And it’s a cheap one as well. Expenses for the ETF run at just 0.40% — or $40 per $10,000 invested.
ETFs to Buy In Case of a Correction: iShares Short Maturity Bond ETF (NEAR)
Expense Ratio: 0.25%
Sometimes cold, hard cash is best. If the correction goes really downhill fast, owning cash and short-term instruments could be an investor’s best bet. And given just how high stocks have climbed since the recession, taking some gains off the table now isn’t such a bad idea either.
Either way, parking that cash into the iShares Short Maturity Bond ETF (BATS:NEAR) is a great idea.
The problem is, cash is still earning a big, fat goose egg. So, the secret is to go slightly out on the yield curve and into ultra-short-duration bonds. That is, securities with maturities of 180 days to 1.5 years. Think of it as cash with a little more “oomph.”
The $2.9 billion NEAR is actively managed and bets on such bonds. The ETF tilts its portfolio toward the corporate sector, with bonds and commercial paper issued by financial, industrial and utility stocks being its major holdings. What that does is provide a 1.62% 30-day SEC yield for what is basically a cash-like investment. Your local savings account isn’t earning anywhere near that.
With low expenses — 0.25% — and decent liquidity, NEAR makes a great correction play as an alternative to low-yielding cash.
As of this writing, Aaron Levitt did not hold a position in any of the aforementioned securities.