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Profit From Bearish Financial Sector With Inverse ETFs

The recent stock market rout has led to sluggish trading in most of the sectors with financials being the worst hit. This is especially true as the S&P 500 Financial Sector Index is down 20% from its peak set in late January, putting it in bear market territory.

What Happened?

Though rising rates are good for the broader financial sector, an inverted yield curve (short-term rates are rising faster than the long term) is taking the shine off. The situation has raised worries about the health of banks and increased chances of default. As banks seek to borrow money at short-term rates and lend at long-term rates, they are earning less on lending and paying more on deposits, thereby leading to a tighter spread. This is restricting net margins and putting pressure on their profits (read: Bank Stocks in Bear Market: Short Sector With These ETFs).

The trend is likely to continue as global growth concerns and falling inflationary expectations led to dovish Fed. The central bank is expected to lift rates for the fourth time this year as soon as this week but may stall rate hikes next year. Powell recently said that interest rates were "just below" the level that would be neutral for the economy — meaning they will neither speed up nor slow down economic growth.

Additionally, sector fundamentals are also deteriorating due to growing concerns about increasing debt load on companies and governments, as well as a build-up of risk and diminished lending quality in the leveraged loan market. Further, banks, which are highly exposed to the energy sector, are once again seeing troubles due to a recent decline in crude oil prices (read: Is Fresh OPEC+ Output Cut Enough to Boost Oil & Energy ETFs?).

Moreover, the ultra-popular Financial Select Sector SPDR Fund XLF, with an asset base of around $24.2 billion and average daily volume of around 76.2 million shares, pulled out more than $2.6 billion from its asset base this quarter, according to data compiled by etf.com.

Given the massive outflow and the bearish outlook, the appeal for financial ETFs, especially banks, has dulled. As a result, investors who are bearish on the sector right now may want to consider a near-term short. Fortunately, with the advent of ETFs, this is quite easy as there are many options to accomplish this task. Below we highlight them and state how each stands out among the rest.

ProShares Short Financials ETF SEF

This fund provides unleveraged inverse (or opposite) exposure to the daily performance of the Dow Jones U.S. Financials Index. The ETF makes a profit when financial stocks decline and is suitable for hedging purposes against fall of these stocks. The product has amassed $25.4 million in AUM while volume is light around 13,000 shares. Expense ratio came in at 0.95%. The product has added more than 7% over the 13-week period.

ProShares UltraShort Financials ETF SKF

This fund seeks two times (2x) leveraged inverse exposure to the Dow Jones U.S. Financials Index, charging 95 bps in fees. It has amassed $29 million in its asset base and trades in a lower volume of around 32,000 shares per day on average. SKF has returned about 25% in the same timeframe (read: Inverse & Leveraged ETFs: What Investors Need to Know).

ProShares UltraPro Short Financial Select Sector ETF FINZ

Investors having a more bearish view and a higher risk appetite may find FINZ interesting as the fund provides three times (3x) inverse exposure to the S&P Financial Select Sector Index. It charges 95 bps per year while the average daily trading volume is paltry at 11,000 shares. It has accumulated $1.5 million in AUM and surged nearly 48% in a span of 13 weeks.

Direxion Daily Financial Bear 3x Shares ETF FAZ

This product provides three times inverse exposure to the Russell 1000 Financial Services Index. Though it charges the same annual fee of 95 bps, it is extremely popular with AUM of $155.3 million and trades in heavy volume of around 2.2 million shares. The fund has gained 38.7% in the same timeframe.

Direxion Daily Regional Banks Bear 3x Shares WDRW

This fund seeks to deliver thrice the inverse return of the S&P Regional Banks Select Industry Index, charging 95 bps in fees per year. WDRW has accumulated $4.4 million in its asset base and trades in paltry volume of around 2,000 shares a day on average. The fund is up 88.6% over the 13-week period (read: 5 Leveraged/Inverse ETFs Soaring in December).

Bottom Line

As a caveat, investors should note that such products are suitable only for short-term traders as these are rebalanced on a daily basis.

Still, for ETF investors who are bearish on the financial sector for the near term, either of the above products could make an interesting choice. Clearly, a near-term short could be intriguing for those with high-risk tolerance, and a belief that the “trend is the friend” in this corner of the investing world.