Bearish sentiment boosts short ETFs

 
Kathleen Brooks
THE global economy is at a crossroads. Fears about a slowdown in China, persistently high unemployment in the US and ongoing concerns about sovereign debt problems in Europe all threaten to weigh on financial markets in the coming weeks.

But the Vix index, the traditional fear gauge for financial markets, has steadily ticked down in recent weeks; it is currently at 23 after spiking above 40 in May – the peak of Europe’s sovereign debt crisis. But while the Vix may have moved to more comfortable territory, according to data from ETF Securities, investors in its exchange-traded funds (ETF) have turned decidedly bearish since April.

Short equity ETFs have dominated trading, accounting for almost two-thirds of trade last week alone. By comparison, short ETFs have averaged just under half of weekly turnover since the start of 2010. Daniel Wills, senior analyst at ETF Securities, says that Europe’s sovereign debt crisis kick-started the craze for short ETFs. However, even though a sovereign default is unlikely in the short-term due to the European Union’s and International Monetary Fund’s bailout plan, ETF investors are still shorting the equity markets.

So what exactly are investors selling? ETF Securities can only offer short equity products on European indices and has most recently noticed that investors werekeen to short the Dax, the German stock index, the FTSE 100 and the Euro Stoxx 50 index.

VOLATILE EQUITY MARKETS

Wills says that this bearish activity is a reflection of the ebbs and flows in the equity market between risk on and risk off: “Investors are keen to take advantage of the volatility and that is fuelling interest in short, leveraged products.”

But how reliable is this data at signalling investor sentiment? ETF Securities is one of the major ETF providers in the capital, so it is a fairly good gauge of sentiment. When the short leveraged ETF launched in June 2009 it was the start of the equity market bull run that lasted until April this year. Back then, the number of short equity ETF’s sold totalled about 50 per cent of total equity sales, according to Wills. However, that has increased in the past three months, rising to just under two-thirds at the end of last week.

Because they are leveraged they are fairly sophisticated and Wills says that the bulk of interest in short leveraged ETFs with his firm has come from institutional investors. However there has been increasing interest from the retail space in recent months.
If you agree that financial markets are at an important juncture and there could be more volatility ahead, a short ETF will give you exposure to the downside.