I don’t blame you if you think we’re on the edge of a bear market…
After all, interest rates on shorter-term U.S. Treasury notes just exceeded the interest rates on longer-term Treasury bonds last week. That hadn’t happened since 2006.
The “inversion” was modest and brief. But importantly, this development is a proven recession indicator. It has flashed only one false signal since 1955.
You already know the rest of the story…
Inflation is up. The Federal Reserve typically responds to crises by slashing interest rates. But with rates already near zero after the COVID-19 pandemic, it can’t do that now.
In fact, the central bank recently increased its benchmark interest rate in an effort to fight inflation. And more hikes are scheduled throughout the rest of this year.
Plus, of course, the war between Russia and Ukraine continues. Even if it ends tomorrow, we’ll still face a potentially new geopolitical order and the need to rebuild Ukraine.
Despite all the uncertainty, the market won’t stay down…
The S&P 500 Index climbed as much as 11% from its March 8 low. And even after pulling back over the past week, the index is still only about 7% away from a new all-time high.
That may seem out of touch to you. And it might look like traders have simply decided to ignore the woes of the world.
But if you look deeper, you’ll see that’s not the case at all. In reality, traders are preparing for financial combat.
Let me explain…
In the past, investors would build a war chest with traditional tools.
They would buy gold. They would move money out of more volatile market sectors and into “defensive” stocks. Or they would do both.
But today, new weapons are available for investors. They’re known as “short” exchange-traded funds (“ETFs”). And folks are using these short ETFs in a big way right now…
To figure that out, I looked at the ProShares UltraPro Short QQQ Fund (SQQQ).
SQQQ is one of the most popular short ETFs. This “3x” short ETF is a bet against the tech-heavy Nasdaq Composite Index. It’s designed to move three times in the opposite direction.
In other words… if the Nasdaq falls 1%, SQQQ should rise 3%. And if the Nasdaq rises 1%, SQQQ should fall 3%.
So investors buying SQQQ need to be sure the Nasdaq is facing more losses. Otherwise, if the trade goes against them, they could lose a lot of money quickly.
With the elevated risk, you would expect this strategy to be only a small part of the market.
Well, that was the case back in March 2019, before the COVID-19 pandemic threw everything out of whack. But today, folks are pouring a lot more money into short ETFs…
Trading in SQQQ has increased roughly 10 times since March 2019. These days, trading in SQQQ equals 14% of the dollar value traded in the most popular ETF for folks who are bullish on the Nasdaq – the Invesco QQQ Trust (QQQ). That’s up from 6% three years ago.
Put simply, traders are stockpiling modern weapons in the form of these short ETFs today.
This trend is something you’ll want to keep an eye on.
After all, the market looks like it’s weathering the storm. But if we look deeper, we can see that traders are preparing for war.
Good investing,
Marc Gerstein
