DPST - DPST: This Is Not The Time To Play With Fire

2023-03-11 04:55:57 ET

Summary

• The Direxion Daily Regional Banks Bull 3X Shares ETF is about as aggressive a fund as one may find in the market.
• I thought that going long DPST in March 2020 made sense — but not so much today, despite the ETF being at a 24-month low.
• While it is nearly impossible to predict price action in the very near term, I think that the bottom for DPST could be well below current levels.

I published one of my most bizarrely well-timed bullish calls on the Direxion Daily Regional Banks Bull 3X Shares ( DPST ) in March 2020. From that moment to the ETF's peak levels reached less than two years later, the vicious bull run that ensued led to gains of up to 400%.

A few days ago, I received a request from a reader: "wondering if you would do a follow up to this article. I have been tracking DPST ETF as a trading instrument and it appears to be again at historic lows." I thought the idea was great, and I address the potential opportunity below.

What Is DPST?

The Direxion Daily Regional Banks Bull 3X Shares ETF is about as aggressive a fund as one may find in the market. It tries to replicate, and it has successfully done so since shortly after its 2015 inception, three times the daily returns of the regional bank sub-sector in the US. The shortcut way of thinking is that DPST should produce three times the daily performance of the SPDR S&P Regional Banking ETF ( KRE ).

DPST is not for the faint-hearted. According to Portfolio Visualizer , the ETF has produced astonishing historical annualized volatility of 78%, which has been nearly five times as high as one standard deviation of the returns of the S&P 500 index ( SPY ). Between March 2018 and September 2020, DPST fell apart: maximum drawdown of 95% (see below). During its worst trading session ever, the fund produced a single-day loss of 45% on March 9, 2020.

The level of risk associated with this ETF is so high that I find it suitable in only two situations, at best: (1) ultra-short-term bets on the direction of regional bank stocks over a period of a few hours or days, or (2) very rare, once-in-a-generation opportunities to buy at the bottom and create an asymmetric trade that offers disproportionately high upside potential relative to downside risk — precisely my bullish case back in March 2020.

This Is Not 2020 All Over Again

I must admit that I am not much of a day trader. For that reason, I will not offer my takes on whether DPST might head higher over the next couple of days or weeks, as I think the upside vs. downside probability within this short timeframe is very much 50-50. Regarding an asymmetric longer-term bet, I believe that buying DPST today makes a lot less sense than it did in March 2020.

The regional bank space is one of the most sensitive to the macroeconomic landscape. The beta on KRE is 1.1 and the correlation between its returns and the broad equity market's has been nearly +0.7. That is to say that regional banks tend to follow the direction of the S&P 500, usually outperforming on the way up and underperforming on the way down. See the ten-year chart below comparing KRE and SPY and notice how the blue line meanders around the orange one consistently.

Back in March 2020, I believed that the market setup was uniquely favorable for DPST. To be clear, the state of the economy was a big question mark. A global recession of epic proportions seemed as likely as, if not more likely than, a swift recovery in economic activity driven by the aggressive fiscal and monetary responses to the COVID-19 crisis.

But unlike today, the stock market was deep in the gutter and interest rates were at zero in early 2020. An eventual reversion to a pre-pandemic reality meant that GDP would eventually stabilize, and short-to-medium term interest rates would come off zero or near-zero levels. That, in my view, was a perfect starting point to place an option-like trade in leveraged procyclicality — that is, contained allocation to a very high-risk asset that can either skyrocket or head to zero, like DPST; coupled with high allocation to a low-risk asset, like cash (what I have called " the bulkhead approach " to investing).

In 2023, things look much different. In my view, an economic slowdown is a near certainty. In fact, I don't think that a recession has been this obviously telegraphed in many decades. The Fed has been crystal clear about how much it is willing to stall economic activity in order to slow down inflation. The yield curve is inverted like it has not been in 40 years (see below). Not many leading indicators have anticipated previous recessions as well as a negative spread between the ten-year and two-year treasury rates.

All of the above tells me that our starting point today is not so optimal for DPST. The mid-to-long term tendency is for the economy to stall and for interest rates to plummet, even if not in the next couple of months. This set up does not bode well for regional banks, despite KRE already being down 30%-plus from the January 2022 peak.

Don't Be A Hero

Before getting to the key takeaway, let me remind the reader that leveraged instruments have particular risks that other investment vehicles do not. Most notably, volatility drag (also known as volatility tax, beta slippage, value erosion, decay, and other names) makes a long-term investment in LETFs more exposed to losses than many realize.

This is the case because these funds reset daily, as per their stated methodology, making it nearly impossible for the long-term performance of the ETF to be equal three times that of the underlying asset — returns can be worse in the case of high volatility in the market. FINRA and the SEC elaborate further on these risks, and I suggest readers go through their warnings thoroughly before committing any capital.

As I watch DPST sink 22% intraday on March 9, I would discourage the reader from betting on this high-risk ETF. While I find it nearly impossible to predict price action in the very near term, I think that the bottom for this fund could be well below current levels. For this reason, I issue a sell rating on DPST.

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