It Almost Never Pays To Short The S&P 500, But This Trade Is Different

It Almost Never Pays To Short The S&P 500, But This Trade Is Different
Stéphane Renevier, CFA

almost 2 years ago2 mins

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If you’re bearish on stocks, shorting the S&P 500 is generally a pretty bad idea. The chart above shows the performance of an ETF tracking the S&P 500 over the last 20-odd years (black line), and the performance of an S&P 500 short (pink line). As you can see, shorting the index almost never works out.

That’s partly down to the fact that you have to pay the dividend yield – no small cost. And since stocks tend to go up over the long term, you’re likely to lose serious money unless you can time the correction perfectly. Even if you do manage to enter at the beginning of a bear market, the intensity of the counter-trend rallies will make it very hard to keep your shorts until the bottom. In 2008, the S&P 500 rallied 30% in the middle of its correction, after all.

To profit from a bearish view, it’s probably better to implement a “relative value trade”: where you buy a defensive sector like healthcare or consumer staples and short the S&P 500 at the same time (orange and blue lines above). That would mean you’re essentially betting that defensive stocks will outperform the broader market. And in tough times, they generally do: people still need toilet paper and anti-allergy pills in a recession, after all.

In fact, both long consumer staples versus S&P 500 and long healthcare versus S&P 500 trades would have returned between 63% and 93% in the tech crash and the global financial crisis. But the best part is that they’re much less costly when you’re wrong. Since the dividend yield of defensive sectors is often higher than the S&P 500’s, you’re actually paid the difference in dividends. That means you can keep the trade going for much longer – and your timing doesn’t have to be so spot-on.

Given the current economic climate, now could be the perfect time for these trades.

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