SH: A Dangerous Way To Position For A Crash
Stuart Allsopp, 21 May 2021
I fully expect U.S. stocks to decline sharply over the coming months and potentially years as the extreme level of valuation and bullish sentiment cannot be maintained indefinitely. I have written about the risks of major losses in the S&P 500 and other indices a number of times over recent months and I remain fully convinced that we are on the precipice of a market crash and/or a long-term bear market. See ‘VTI: Rising Inflation May Burst This 3-Sigma Bubble’ for my most recent article on U.S. stocks, or ‘SPX: Don’t Be Suckered In By ‘Low’ Forward P/E Ratios’ for my take on the S&P 500 in particular. That said, I do not think being long the ProShares Short S&P 500 ETF (NYSEARCA:SH) is a good way to take advantage of the upcoming equity weakness.
SH Is A High-Risk Option For Gaining Downside Market Exposure
Risk management is equally, if not more, important than getting the major market moves right, and the SH is a high-risk option. Even for those investors with little alternative to get exposure to S&P 500 downside, I would not recommend this ETF other than for savvy market timers who intend to hold their position for a matter of days rather than weeks or months.
The reason being that although the SH prospectus seeks to track the inverse of performance of S&P 500 over any given day, and indeed does this reliably the majority of the time, when holding for any long period of time the high expense ratio makes it a costly investment. Moreover, the fund has a tendency to drastically underperform its stated goal during times of large S&P 500 declines, which is exactly when you want your hedges to not let you down.
Dramatic Long-Term Underperformance Relative To Underlying Market
We can see this by looking at the performance of the SH versus the S&P 500 over the past 15 years. The SH has lost 89% of its value since its inception in 2006, while the S&P 500 has risen 334%. This means that if the SH tracked the inverse of the S&P 500 it would have declined by 70%. This equates to a 6.2% average annual underperformance for the index relative to its stated benchmark. In part this reflects the fact that investors have to pay the dividend yield when they are short the S&P 500, which has averaged just 2.1% over this period. Adding in the 0.9% expense ratio gets us to 3%. This means that an additional 3.2% decline has taken place which cannot be easily explained.
