Gamble of the week: Profit from a fall in US stocks

published 28 June 2012

ProShares UltraPro Short S&P 500 ETF (NYSEP: SPXU)

This leveraged exchange-traded fund, available on the New York Stock Exchange, targets returns corresponding to three times (300%) the inverse of the daily performance of the US' benchmark equity index, the S&P 500. It is really only suitable if you think that US equity markets are long overdue a correction and that a fairly dramatic one will happen soon.

On valuation grounds, there are reasons to believe that some form of reversal is justified. Whereas most European stock indices are showing losses for the year to date (for obvious reasons), the S&P 500 remains stubbornly in the black.

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But as SocGen analysts Albert Edwards and Dylan Grice recently pointed out, whereas the ten-year smoothed p/e ratio for European stocks now stands at a lowly eight or so (which is where the markets were back in 1982, at the dawn of the last great equity bull market), in the US, stockmarkets stand at a cyclically adjusted p/e ratio of 19 or so which is above where they were before the 1987 crash.

For anyone that can stomach the volatility and the potential risk to capital, the ProShares fund offers an interesting way of playing a sudden reversal in US stocks. But beware: this is not a gamble for widows or orphans. The daily repricing mechanism used by these funds can make their performance hard to predict in volatile markets.