LABU - Leveraged Biotech ETFs: Hold LABU Sell LABD

2023-04-19 14:13:51 ET

Summary

• SPDR® S&P Biotech ETF, the Biotechnology Select Industry Index ETF, has an extreme short interest of 51.16%.
• XBI is in an uptrend since May-June 2022.
• Direxion Daily S&P Biotech Bull 3X Shares ETF, the 3X leveraged Biotech ETF, is rated as a HOLD.
• Direxion Daily S&P Biotech Bear 3X Shares ETF, the -3X inverse leveraged Biotech ETF, is rated as a SELL.

Investment Thesis

The Biotechnology sector has been one of the first sectors to recover in June 2022, posting a healthy two-month rally. After the August top, SPDR® S&P Biotech ETF (XBI) entered a consolidation stage that finished with a big drop in February-March of 2023. For the last three weeks, XBI made small but consistent gains. My thesis is that this rally has good chances to establish a floor to the downward drift. On this basis, I rate XBI as a HOLD.

XBI is the non-leveraged exchange-traded fund ("ETF") of the Biotechnology Select Industry Index. Direxion Daily S&P Biotech Bull 3X Shares ETF (LABU) and LABD Direxion Daily S&P Biotech Bear 3X Shares ETF (LABD) are 3X leveraged funds of the same index. Based on the same thesis, I rate LABU as a HOLD, and LABD as a SELL.

Analysis

XBI is an equal-weighted fund investing in 150 mostly small-cap stocks. Another ETF, iShares Biotechnology ETF (IBB), is a cap-weighted of 276 all-cap biotechnology stocks. Over a very long time, the two ETFs have about identical returns. Both, XBI and IBB, have returned about 400% over a 17-year period, from 2006 to 2023.

XBI is a lot more volatile than IBB; that means that it makes larger gains or losses in a shorter time. That may also be a reason why XBI is favored by some traders. While IBB has a short interest of 15.74%, XBI has an extreme level of 51.16%.

XBI has suffered extreme losses (-64%) from its peak in February 2021 to its bottom in May 2022. For comparison, the peak-to-valley losses of IBB (-40%), QQQ (-35%), and SPY (-24%).

A simple correlation analysis shows that XBI has higher correlation with growth and small-cap than with value and large-cap. These factors explain why XBI is negatively affected by any market worries about the economy and the banking system.

Despite the negative press and the concerns about the health of the credit conditions, the market has been very resilient for the last six months. The AMI market risk indicators has been risk-on since October 2022. This is the main argument in favor of a continuation of the market recovery.

XBI vs. Leveraged ETFs LABU and LABD

To illustrate the relationship between XBI and its leveraged counterparts, following are their 2-year weekly charts.

The first chart below shows that XBI established a double-bottom in May-June 2022, and that the uptrend started at that time is still intact. While it is quite possible that the XBI uptrend may fail, I believe that for a longer time horizon, the most likely scenario is to get a strong recovery. In my opinion, the 51.6% shorts are irrational, and those shorts may cause a forced rally when market sentiment gets a boost.

The next chart shows that LABU has reached again the May-June bottom values. This is a typical example of why leveraged funds are not suitable for long term investing when the underlying index is trading in a range. For that reason, I believe that LABU is only a HOLD.

LABD established a top in May 2022. Since then, it is in a continued downtrend. Therefore, I rate LABD as a SELL.

Conclusion

Although XBI has an extremely high short interest, I believe that the short position has very low chances of being profitable for any intermediate and long-term horizons. Therefore, I rate XBI as a HOLD.

Similarly, LABU trades at extreme low levels and I rate it is as a HOLD.

LABD is rated as a SELL.

Risk Warning

Here is a detailed message from the SEC on the risks inherent in leveraged ETFs.

For further details see: