ETF Investments for an Economic Slowdown

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We have seen several signs that an economic slowdown is coming, which I have outlined here. Specifically, they include:

  • Weak price action in copper. I should note that we have seen weak price action in other industrial metals as well such as lead and zinc. Weak demand for industrial metals indicates weak demand for industrial goods more generally.
  • Weak export data coming out of China. China is America’s biggest trading partner. With Chinese exports plunging this suggests that there is economic weakness in the United States.
  • Retailers are reporting weak numbers. Bellwether companies from Wal-Mart Stores (NYSE:WMT) to Home Depot (NYSE:HD) are reporting weak sales figures and declining margins, which means that American consumers are not buying as much as they were in prior months and years.

Given these points, investors should consider making changes to their portfolios that reflect this weakness. This means selling most stocks, especially those that are economically sensitive and those that are trading at lofty valuations. It also means adding positions in assets that will perform well in an economic slowdown. In what follows, I list some ETFs that should rise, or at least outperform, during an economic slowdown. A portfolio that includes them should be better prepared for a bear market and a recessionary environment, and it will be ready  to purchase economically sensitive assets once the time comes to do so when prices are lower.

1. Proshares Short S&P 500 ETF (NYSEARCA:SH)

This ETF trades inversely to the daily performance of the S&P 500. If the S&P is up 1 percent, then this fund goes down 1 percent. If the S&P 500 falls 1 percent, then this fund rises 1 percent. Should the economy weaken, we will almost certainly see a large correction in stocks, and funds such as SH are going to perform well in such an environment. Before buying SH, investors need to be aware of the fact that these funds “reset” after each day, meaning that if the S&P 500 is down 10 percent over a three week period, then this fund will not necessarily be up 10 percent.

Consider the following example in which SH shares start out at $100/share, which is a level that is easy to work with. Suppose on day one, the S&P 500 rises 10 percent. SH will fall to $90/share. Suppose then that the S&P 500 falls back to its starting point, which means that it falls about 9.1 percent. SH rises 9.1 percent, but this only gets the shares back up to $98.19. In other words, the S&P 500 was flat, but the inverse fund fell by 1.81 percent. For this reason, investors need to treat SH as a trading vehicle, which means that they need to use stop orders and monitor its progress regularly.

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