Bears Are Back and They're Buying This
Many new investors quickly learn how to make money by buying stocks that rise in value. But figuring out how to profit from investments that you don't think will be successful can take a lot longer. As the universe of exchange-traded funds continues to grow, investors who want to bet on a bad spell for the stock market have more choices than ever.
The challenges of selling stocks short
Short-selling has a terrible reputation. Investors who tout stocks and their bullish prospects generally avoid criticism, even when their picks go awry. But because short-sellers profit when others lose money on their investments, they draw scorn like a magnet, from the companies they bet against to the shareholders on the other side of their trades. During the financial crisis, for instance, both Citigroup (NYS: C) and Morgan Stanleyblamed short-sellers for many of the problems they faced in accessing the capital markets. Some even see the practice as somehow "evil" or immoral.
But proponents of short-selling argue that without it, there's no check on companies trying to puff up their bullish prospects. Short sellers pierced the housing bubble, and discovered the fraud that led to the Enron collapse. It's impossible to predict how much further those situations could have gone without the moneymaking opportunity that short-selling created for investors willing to buck prevailing sentiment.
ETFs from the dark side
The rise of ETFs, however, has made short-selling a lot easier for investors. From broad-market bearish positions that ETFs like the double-leveraged ProShares UltraShort S&P 500 (NYS: SDS) provide, to sector-specific bets such as Direxion Daily Financial Bear 3x (NYS: FAZ) , index-based short selling lets you benefit from short-term downward movements in the investments you target.
The problem with most bearish ETFs -- especially leveraged ones -- is that they're not suitable for long-term investors. Leveraged ETFs' focus on daily returns can create big problems for those who hold them even for a period of months, let alone years.
But a new actively traded bearish ETF opened its doors earlier this year. Amid concerns about the prospects for the economy going forward, Barron's recently noted that investors have started paying much more attention to the Active Bear ETF.
Take a look at the Active Bear ETF, and you'll find just about everything you'd expect from an exchange-traded fund. But instead of owning holdings, this fund takes short positions.
The ETF's finding the most shorting opportunities right now in two sectors: technology and industrials. In fact, industrials lead the top positions, both through an investment in the Industrial Select Sector SPDR ETF, and in individual stocks like Rockwell Collins (NYS: COL) . On the tech side, you'll find solar giant First Solar (NAS: FSLR) , as well as circuit-maker Jabil Circuit (NYS: JBL) .
One bad move can kill you
When you look at Active Bear's performance, you'll see one problem that can plague short sellers: It takes just one bad move to cause serious damage. Most of the ETF's top holdings have done what you'd want them to do: They've fallen for the year. Rockwell, for instance, saw revenue drop as global defense spending remains under pressure. First Solar leads its industry in cost per watt, but cutbacks on subsidies have weighed on the entire solar sector. And Jabil Circuit has suffered from a lack of demand at some of its major customers.
But the ETF made a big mistake by holding Green Mountain Coffee Roasters (NAS: GMCR) . Despite a high valuation, the stock has more than tripled year to date amid ever-increasing demand for its Keurig machines and K-Cups. That alone has been enough to give the ETF an overall loss since the fund started in January, even though the S&P 500 has also lost ground since then. With the ETF carrying an annual expense ratio of 1.85%, investors will want to see better results than that to justify its price tag.
The right move?
Shorting stocks can be lucrative, but as Active Bear's experience shows, you have to be careful. The potential for unlimited losses on short sales is very real. But with lots of shorting choices at your disposal, you may want to give the strategy a second look.
ETFs have the flexibility and utility that you want for your investing. The Fool's special free report, "3 ETFs Set to Soar During the Recovery," can point you in the direction of some great ETFs that just might deserve a place in your portfolio. Click on the link to get started with no obligation.
At the time this article was published Fool contributorDan Caplingerstarts looking for bargains when the bear growls. You can follow him on Twitter here. He doesn't own shares of the companies mentioned in this article. Motley Fool newsletter services have recommended buying shares of Green Mountain Coffee Roasters and First Solar. Separate services have recommended creating a lurking gator position and shorting Green Mountain Coffee Roasters. Try any of our Foolish newsletter servicesfree for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool'sdisclosure policyis cuter than a panda bear munching bamboo.
Copyright © 1995 - 2011 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.