DPST - DPST: The Lotto Ticket After A Credit Event

2023-09-11 14:22:04 ET

Summary

• Direxion Daily Regional Banks Bull 3X Shares ETF is a leveraged ETF designed to provide exposure to the regional banking sector.
• The DPST fund's leverage resets daily, making it unsuitable for long-term investment strategies in high volatility cycles.
• DPST's performance is influenced by interest rates, the health of the regional banking sector, and overall market volatility.

When you combine ignorance and leverage, you get some pretty interesting results. - Warren Buffett.

Trading with leverage in volatile markets can be an exhilarating, but also extremely, dangerous. I've continued to hammer in my work the idea that conditions favor a credit event given the fastest rate hike cycle in history only now impacting the stock market and U.S. economy. If I'm right, there would be a broad and aggressive risk-off move. The last thing you want is to hold onto any levered equities during that period, especially in regional banks which could suffer disproportionately. At the same time, there could be some incredible returns timing levered regional banks after a dislocation.

That's why DPST (DPST) is interesting to keep on a watch list now. DPST is a leveraged Exchange-Traded Fund, or ETF, designed to provide investors with exposure to the regional banking sector. The fund's daily investment results, before fees and expenses, seek to achieve 300% of the performance of the S&P Regional Banks Select Industry Index .

Investors and traders should note that this fund's leverage resets daily, making it inappropriate for long-term investment strategies in high volatility cycles which I suspect we are just about to enter into . Simply put, the fund's performance over periods longer than a day will not be three times the benchmark's cumulative return . In low volatility periods, it likely would actually be higher as daily positive streaks are more apt to occur. In high volatility periods? Forget about it. A simple illustration of market movement in August 2011 from my paper "Leverage For The Long Run" proves this.

DPST's Holdings

The fund primarily invests in stocks that are part of the S&P Total Market Index and classified in the Global Industry Classification Standard ("GICS") regional banks sub-industry . As of June 30, 2023, 100% of the fund's investments were in regional banks .

Some of the top holdings include New York Community Bancorp, East West Bancorp, and M&T Bank Corporation . These holdings, however, constitute a relatively small percentage of the notional exposure. Most of the exposure comes from its swaps, financial derivatives where two parties exchange the cash flows or returns from two different assets or indexes.

DPST's Expense Ratio

Managing a leveraged ETF like DPST incurs expenses. The fund currently carries a gross and net expense ratio of 0.93% . While this might seem reasonable for a 3X leveraged fund, the costs can add up over time, cutting into potential profits.

DPST's Performance

Unlevered regional banks are volatile and have remained so since the March crisis took place. Volatility is the enemy of leverage, and while it's tempting to lever up a beaten down part of the marketplace like regional banks, the odds have been against you. Relative to the SPDR S&P Regional Banking ETF (KRE), DPST had a good run from May to end of July, but since then, unlevered regional banks have been the better relative performer.

The Current Macro Landscape

The current macroeconomic environment poses significant challenges for regional banks, and by extension, DPST. The Federal Reserve is committed to slowing economic activity to contain inflation, which could negatively impact regional banks . Moreover, the yield curve is inverted, suggesting an impending recession . This could exacerbate DPST's performance in the near term, as regional banks tend to underperform in economic downturns.

A Speculative Bet

Given the risks and current macroeconomic environment, DPST can be seen as a speculative bet. Its performance is heavily influenced by factors such as interest rates, the health of the regional banking sector, and overall market volatility.

Investors considering DPST should be prepared for potential losses and should closely monitor their positions. This is not a set-and-forget type of investment. It requires active management and a good understanding of the underlying risks. DPST may be tempting to bet on, but I personally would rather wait for a big risk-off period for stocks to pass. Timing is everything here.

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