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Trade These Inverse ETFs As Interest Rates Spike

From Zacks: Rising rate concerns are likely to flood the market as both Fed rate hike and increased inflationary expectations pushed up Treasury bond yields. First, hopes of fiscal reflation in Trump’s presidency boosted the benchmark U.S. Treasury yield (read: 9 Winning ETF Ways for Those Who Fears Rising Yields).

Plus, the Fed expedited its sole Fed rate hike of 2016 by a modest 25 bps to 0.50–0.75%, attesting the U.S. economy’s growth momentum and a tightening labor market. If this was not enough, the Fed has now forecast three rate hikes in 2017, up from two guided in September.

Notable changes were noticed in the projection for the benchmark interest rate for 2017, 2018 and 2019. Projections for 2017, 2018 and 2019 were ticked up from 1.1% to 1.4%, 1.9% to 2.1% and from 2.6% to 2.9%, respectively. These are meaningful jumps from the 2016 projected rate of 0.6%. The Fed’s funds rate for the longer run was raised to 3% from 2.9%.

The dual dose of Fed and Trump revved up benchmark U.S. Treasury yields. The yield on the 10-year Treasury note rose to 2.54% on December 14 from a low of 1.37% seen in early July. This situation knocked off rate-sensitive sectors in recent sessions (read: Sole Fed Hike of 2016 Put These ETFs in Focus).

Against this backdrop, high dividend paying sectors including utilities and real estate are in peril given their sensitivity to changes in interest rates. These sectors are capital intensive in nature. As the funds generated from internal sources are not always enough for meeting their requirements, these companies need to depend on the debt market highly.

As a result, a rising rate environment works inversely to these sectors as companies will now have a higher interest obligation. Also, these high-yielding sectors fall out of income-hungry investors’ favor if rates rise. Needless to say, investors would like to stay away from these sectors in the coming weeks.

In spite of excusing themselves from these stocks altogether, investors could make a short-term bearish play on the rate-sensitive sectors which will see choppy trading if interest rates maintain the ascent.

ETFs to Play

For them, we highlight a few inverse utility and real estate ETFs, any of which could be an intriguing pick in the near term. These sector ETFs could see a strong surge as the faster Fed hike bets look stronger.

ProShares UltraShort Utilities (SDPFree Report)

This fund seeks to deliver twice (2x or 200%) the inverse return of the daily performance of the Dow Jones U.S. Utilities Index. The product was up about 4.6% on the day the Fed hiked rates (read: ETF Strategies for a Rising Rate Environment).

ProShares Short Real Estate ETF (REKFree Report)

This fund seeks to deliver the inverse return of the daily performance of the Dow Jones U.S. Real Estate Index. The ETF makes profits when the real estate stocks trend down and is suitable for hedging purposes against the fall of these stocks. REK added 1.5% on December 14, 2016.

ProShares UltraShort Real Estate (SRSFree Report)

The fund offers two times inverse exposure to the performance of the Dow Jones U.S. Real Estate Index. The ETF advanced about 3.9% on December 14, 2016.

Direxion Daily Real Estate Bear 3X ETF (DRVFree Report)

This product seeks to deliver three times the inverse performance of the MSCI US REIT Index. The ETF gained over 6.7% on December 14, 2016.

Bottom Line

As a caveat, investors should note that these products are suitable only for short-term traders as these are rebalanced on a daily basis. Moreover, the underlying fundamentals of these sectors are strong given the decent U.S. economic growth momentum. So, inverse ETFs on these sectors might be immediate beneficiaries post rate hike, but may see sluggish trading once the move is priced in.

This article is brought to you courtesy of Zacks Research.

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