The best way to short US stocks

Paul Amery explains how you can use an inverse exchange-traded fund to profit from falling US share prices.

Pull up a five-year chart of the FTSE 100 or the S&P 500 (see chart), you'll notice two things. Stock markets have moved up steadily since bottoming in 2009, and the dips have been getting progressively shallower as markets have moved higher.

This may suggest that the victory of the stock-market optimists is complete. But, according to US fund manager John Hussman, these are signs of a peaking market.

Before a major top, markets often experience "a nearly uncorrected upward ramp in which virtually every dip is purchased as soon as it emerges".

Hussman has been a sceptic for some time. So it's easy to ignore him. But he adds that the US market's current "overvalued, overbought and overbullish" state, combined with rising bond yields, has been seen just six times in the past: August 1929, November 1972, August 1987, March 2000, May 2007 and January 2011.

In all but one of these cases, the market then fell by 50% or more. Only in 2011 was the drop limited to around 20%, due to central-bank intervention.

Now, calling a top is a fool's game, admits Hussman. Apart from anything else, he notes that a parabolic top in the S&P 500 could see the index (currently at 1,770-odd) hit 1,900 by January.

For stocks to fall, investors also need to lose faith that central banks can inflate asset prices indefinitely. That's not happened yet: "Quantitative easing is novel, and like the internet bubble, novelty feeds imagination", Hussman argues, recalling the tech bubble of 1999/2000.

But if you think Hussman's on to something, you can bet on a fall using an inverse (short) exchange-traded fund (ETF).

As the name suggests, these ETFs produce a return that's the inverse of the underlying index's return. So if the S&P 500 index falls 2% in a day, an inverse fund would rise by 2% (minus a small adjustment for fees) and vice versa.

What you must remember is that, because of daily rebalancing', an inverse ETF only returns the inverse of the index over a single day: over time the fund's return will diverge from that mirror image of the index's return.

But inverse ETFs are also safer than other ways of shorting, such as spread betting with an ETF you can't lose more than you invest.

For investors who would like to position for a US stock-market fall, the db x-trackers S&P 500 Inverse Daily ETF (LSE: XSPS) which I own is the obvious choice among London-listed funds.

Paul Amery, formerly a fund manager and trader, is now a freelance journalist.

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