Bearish signals flashing! U.S. stocks rebound but fear is growing in the $9.5 trillion ETF market

In the $9.5 trillion ETF market, there are increasing signs of pessimism, which may pose a threat to the Wednesday's rise in US stocks bought on dips. Trading activities show a growing demand in the market for some ETFs, which are profiting from the decline in large tech stocks, small companies, and semiconductor stocks.

Taking leveraged investment products as an example, these products aim to create returns that are two or three times the inverse performance of the S&P 500 Index, NASDAQ 100 Index, Dow Jones Industrial Average, small-cap stocks, and chip manufacturers. Data compiled by Strategas Securities shows that the trading volume of the top 10 ETFs tracking these themes has steadily increased this month.

Todd Sohn, an ETF strategist at the company, stated that investors tend to trade these products more actively when the market is sluggish. He pointed out, "The number of inverse products is a measure of fear and anxiety."

Data compiled by Bloomberg's Athanasios Psarofagis shows that the daily trading volume of leveraged inverse ETFs is rising compared to long ETFs, another sign of increasing risk aversion. The bias still leans towards long positions, but the gap is the smallest since last year. These high-intensity inverse ETFs that use derivatives to enhance returns have become a popular way for traders to express their views.

Indeed, the US stock market rose on Wednesday, led by chip manufacturers, and the latest CPI data reinforced expectations of a 25 basis point rate cut by the Federal Reserve next week. Despite the sharp decline in the S&P 500 Index last week, it has risen by about 16% so far this year.

However, the trading of these ETF products highlights Wall Street's concerns about the AI-driven rally. Mike Wilson, a well-known bear on Wall Street and strategist at Morgan Stanley, stated on Wednesday that this boom has "gone too far."

Other market indicators also show similar concerns. For example, data from financial analytics company S3 Partners shows that the short interest in the $31 billion iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD.US) has reached its highest level since June last year. Psarofagis said that the typical buy-on-dips mentality has recently been relatively weak in ETFs as well. Data shows that compared to this year, stock ETF flows from 2021 to 2023 have been much stronger in the weeks following a comprehensive decline in the US stock market.

Mohit Bajaj, the ETF director at WallachBeth Capital, believes that all these indicators may simply indicate that investors are waiting to see the outcome of next week's Federal Reserve meeting. He said, "With the Fed's upcoming policy announcement and the index rebalancing in September, the market has experienced some volatility. Many investors are just waiting for things to stabilize a bit, which is not surprising."