SQQQ stock

Shorting the US Stock Market with SQQQ – what you need to know.

ProShares UltraPro Short QQQ ETF (NASDAQ:SQQQ) is a leveraged (3x) ETF that inversely tracks the Nasdaq 100 index. The ETF gained serious popularity amongst investors during the market crash in March 2020, and is beginning to attract investors again with current inflationary concerns and the Ukraine border crisis disrupting market confidence. It is important to understand the instrumental purpose of certain ETF’s before looking to invest.

The SQQQ is a highly risky tool for day-traders and speculators, designed to short the US market over short periods of time, in this case the Nasdaq 100. The inverse 3x leverage on this ETF means it will reflect a skewed inverse relationship with the Nasdaq index, which is seen to have a negative relationship with time (on average). Lets breakdown understanding the ETF and why people are looking at SQQQ for a potential downturn in the market.

Understanding SQQQ’s main function for investors

At its most basic level, the SQQQ ETF is designed to give speculators and day traders a way to capitalise when they suspect the US market to correct or fall. The 3x leveraged inverse relationship simply means day by day, when the NASDAQ 100 index decreases by 3% – SQQQ will gain 9% and vice versa (note: the returns are not perfectly 3x due to the way inverse ETF’s work). Proshares discloses that the main function for SQQQ is to be traded over short periods of time (intraday).

For example, if we look at the performance of SQQQ over the past 3 years, we can see it has lost 99.1% of its value. However, if we look at the 1 month performance between February and March 2020, SQQQ gained roughly 78%. Hence providing speculators and day traders with great returns whilst the market went into free fall.


Understanding what SQQQ is shorting?

Warren Buffet is known for his advocacy in thoroughly understanding the business you are buying shares in. In the same sense, understanding how an ETF moves is critical for an investor when forging an investment strategy. The NASDAQ 100 index is a basket of 100 large US listed companies (non-financial sectors) including the likes of Apple and Facebook. See the full list of 100 companies here.

In essence, the SQQQ is betting against some of the largest US corporations combined into one index, weighted by their market cap respectively. But instead of simply shorting, SQQQ is tripling down on the performance of these companies.

If we can learn anything from history, long term bets against US corporations (as a collective) never pan out well. However, intra-day bets against US performance can prove a profitable strategy assuming the market sentiment is bearish.

The current state of the US market outlook is beginning to deteriorate from levels we saw in 2021. We know that the NASDAQ100 index has outperformed the SP 500 index in recovery after the March crash. The tech rally is definitely an explanation for the fast recovery of the NASDAQ 100, with 6 big tech corporations making up half of the indexes weighting.

The heavy weighting of tech in the index can be an argument for SQQQ if a tech correction is to occur. However, intra-day timing is crucial as SQQQ gains are historically short lived.

The current market sentiment is in tug of war between the bulls and the bears. Firstly, in April last year, data from the Financial Industry Regulatory Authority revealed investor margin level debt had reached an all time high.

High levels of margin level debt was also seen prior to the dotcom crash and the GFC. If we pile on inflationary pressures and precendented monetary policies to combat this, it is seen by some as a perfect storm brewing.

This of course is not to mention the economic implications and inflationary pressures of the European conflict in Ukraine. As Russia is one of the largest oil exporters in the world, analysts expect prices to reach new highs as sanctions disrupt trading with Russian exporters.

What the Warren Buffet indicator has to say about the US market

The Buffet Indicator, is a measure of the value of the stock market compared to Gross Domestic Product (GDP). The indicator currently sits at 57% above the historical average, suggesting the market is overvalued to an extreme. Here’s what Warren Buffet had to say about the Buffet valuation indicator roughly 20 years ago following the dotcom crash:

The ratio has certain limitations in telling you what you need to know. Still, it is probably the best single measure of where valuations stand at any given moment. And as you can see, nearly two years ago (prior to dotcom crash) the ratio rose to an unprecedented level. That should have been a very strong warning signal.

While extreme valuations are becoming more normalised in todays market, the Buffet indicator has been sharply rising since the GFC. With higher valuations, inflationary concerns and future interest rate hikes, we can see why some investors are beginning to look into the SQQQ ETF.

SQQQ stock
Wall street sign in New York with New York Stock Exchange background

Another market crash could provide SQQQ investors an opportunity to cash in on a potential decline. However the associated risk with timing this investment should always be calculated and monitored as per Proshares recommendations.

Overall, an understanding of how SQQQ ETF works is crucial as the ETF is a specifically designed, inverse investment vehicle. With valuation, inflationary and supply chain shortages, we can see why investors are taking another look at SQQQ stock. In saying this, the market has been stubbornly bullish since the COVID-19 correction in March 2020, and betting against the top 100 companies in the United States brings about its own risks, few dare to take.

If you want to learn more about SQQQ, click here.

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The information above is not financial advice. Youth Investment Group has no liability for personal financial interests or investment decisions. You should make your own investment decisions based upon your own research and what you believe is best for you.

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