Is using Inverse ETFs akin to Market Timing?

Early in 2020, I re-positioned a meaningful portion of my clients’ equity positions into inverse products (they go up when the market goes down and down when the market goes up).  Critics, colleagues, suppliers and friends have seized the opportunity to call me a “market timer.” I beg to differ.

What I am doing is putting something that might be generally described as a form of insurance in place: expressly in light of high valuations.  The Shiller CAPE (a widely accepted benchmark for market valuations) for the S&P 500 is currently over 31 and has hovered between 28 and 33 for about three years now.  The historical average is under 17.

Think of buying a ten-year life insurance policy when you take on a mortgage.  Is that an example of “death timing?  Are you buying insurance because you EXPECT to die in the ensuing decade – or simply to protect against the consequences of something terrible happening?

If you don’t die in the decade, but still have a mortgage, are you ‘stubbornly doubling down’ after having made the ‘wrong call’?  If a decade were to pass and you were still breathing, was the money spent on premiums over the previous decade ‘wasted’?  To hear my critics … and to extend their logic based on what they are telling me, the answers would all be an accusatory “yes” to all these questions.

Here’s my thinking as explained via metaphor:

What I’m saying/ doing                    The Insurance Equivalent

Inverse sleeve                                   Term life insurance

Temporarily high valuations                Temporary unfunded liability on death

Renew if still high                               Renew if unfunded liability persists

Cancel if no longer high                      Cancel if unfunded liability is paid off

Offer relief if markets tumble               Offer relief if premature death

Everyone dies eventually.  Markets always have major pullbacks eventually.  No one knows when either is likely to happen.  See the parallel? Despite all this, people are generally portrayed as being “prudent” when they buy life insurance, but “market timers” when they incorporate an inverse sleeve.  I simply don’t buy it.  Perhaps I should start challenging my critics, colleagues, suppliers and friends for their “reckless disregard for the substantial risk they are taking while doing nothing to manage that risk.”  See what I did there?

John De Goey, CIM, CFP, FP Canada™ Fellow, is a Portfolio Manager with Toronto-based Wellington-Altus Private Wealth Inc. This blog originally appeared on the firm’s “Newswire” site on Feb. 5, 2020 and is republished on the Hub with permission.