SPY, QQQ, TLT Volatility Can Be Hedged With Inverse ETFs

Just a week ago, market pundits were falling over their skis to see who could be more bullish for 2024. Market bears went into literal hibernation. 

While the bull scenario may play out as a result of well-considered rate cuts, the stock and bond markets did what they do best last week. Mess with everyone’s head. 

The SPDR S&P 500 ETF (SPY) fell to start the year, as did other major averages. The Invesco QQQ Trust ETF (QQQ) weighed the market down as the tech-heavy index likely suffered from investors selling its highly appreciated largest holdings in a new tax year. 

Small caps suffered particularly, and bond ETFs, including the iShares 20 Plus Year Treasury Bond ETF (TLT), reversed late-2023 rallies that were historic in magnitude. The 10-year U.S. Treasury bond, which ended last year at a 3.88% yield spiked 4.10% before settling the week at 4.04%.

That increase is significant when you consider that at the short end of the yield curve – where investors grapple about the direction of overnight interest rates set by the Federal Reserve – the market raised the 10-year rate by nearly a quarter-point in under four trading days, without the Fed saying a word. That’s what analysts mean when they say, “the market is doing the Fed’s work for them.” 

In the same way that fans shouldn’t fret when their favorite baseball team gets swept in a three-game series to start a long season, the first week of January should not spur panic. But January has a way of shocking investors and financial advisors, especially if the malaise carries deeper into the month. It was that type of year in 2022, and the memories are still fresh for many. 

Hedging With Inverse ETFs 

That’s why ETF investors should remember that when it comes to flexibility in their investment process, they are in the proverbial catbird seat, and that many parts of the market can essentially be owned in reverse, without risky leverage.

Single inverse ETFs have existed for many years, but they became more popular during the 2020 pandemic crash, in which the S&P 500 index fell 33% in five weeks. These simply aim to perform opposite a market index, daily. 

These ETFs must be researched carefully due to the math of investment loss, which is why they are considered trading vehicles. An investment that moves opposite the market is certainly not assured to deliver, say a 10% gain, when the benchmark loses 10%. That mirror image relationship works fine on a one-day basis but can vary more over time. 

RWM, QQQ and Beyond 

But the reality is that many inverse ETFs have been consistently contrarian performers versus their benchmarks over longer periods. That makes them good alternatives for investors who either want to hedge existing exposure to areas running into trouble, or to target areas they expect to underperform versus the broad market. 

For instance, during the first 10 months of 2023, the ProShares Short Russell 2000 (RWM) rose 9%, even while the large cap market was up. QQQ gained 32% during that time. So, there are times when even an inverse ETF used to hedge can profit alongside a “long” ETF position. 

Hedging, profiting from down market periods, diversification and other potential benefits of inverse ETFs provide investors and financial advisors with a straightforward method of playing defense. Or offense. 

Their premise should be simple to explain to advisory clients. With markets starting 2024 differently than many expected, consider this annual reminder that single inverse ETFs can be portfolio aids.