WEBL - WEBL: Narrow Rally Exposed To Rate Hike Disappointments

2023-06-13 10:40:44 ET

Summary

• Tech has been leading the charge of this recent bull market, and while we agree with the sentiment that the inflation picture is less concerning, there are still risks.
• Tech stocks are especially exposed to rate revisions. Long-term rates are going to be important for the valuations of these companies.
• It's generally expected that interest rates will reverse over the next 12 months, but long-term rates matter quite a lot and supply issues are more likely now than before.
• With longer-term deglobalization being a constant upward pressure on inflation, the era of ultra-low interest rates may be mostly over, and we don't think the market acknowledges this yet.
• With Direxion Daily Dow Jones Internet Bull 3X Shares ETF being a leveraged instrument, and with a good chance that even in the short term, the rally may be overdone, we'd stay away from this especially aggressive fund.

The Direxion Daily Dow Jones Internet Bull 3X Shares ETF (WEBL) is a high-leverage exchange-traded fund ("ETF") that tracks the Internet and tech stocks of the U.S. Tech has been leading the market rally in the U.S. thanks to hype around generative AI. While AI is quite important, we don't see generative AI being quite as revolutionary as markets believe.

More importantly though, we are concerned with the fact that WEBL in particular is exposed to the part of the markets that are most exposed to long-term rate forecasts. While the yield curve does imply higher rates for the long-term, considering the importance of horizon values in tech valuations, we don't think equity markets necessarily agree with that smart-money appraisal. Considering the leverage with WEBL we'd stay away.

Note on Leveraged ETFs

Because they reset daily after mimicking changes in the index that day by a 3x factor in the case of WEBL, there is the problem of value erosion. While a 1% rebound after a 2% drop isn't so bad for the underlying index, having a 6% drop and a 3% rebound is more of a problem. There is a reason why Warren Buffett's #1 rule is, don't lose money. If you lose money, you have less to recover with, meaning for every drop you need a bigger percentage recovery to bring you back to square 1. If an asset drops 33%, you need an almost 50% recovery to recover. If an asset drops 50%, you need 100% recovery to breakeven. Even if the next day is a bigger rebound than what you lost the previous day, with leveraged ETFs it is still less helpful even if the recovery gets doubled because more money was lost the prior day.

If you don't fully understand these risks, do not proceed with a leveraged ETF. They are best used over short durations because of value erosion. They are highly speculative burst instruments.

Links for reference on these risks:

• The Lowdown on Leveraged and Inverse Exchange-Traded Products
• Leveraged and Inverse ETFs: Specialized Products with Extra Risks for Buy-and-Hold Investors
• Regulatory Notice 09-31 | FINRA.org

WEBL Breakdown

The index that WEBL tracks has the following exposures.

The Internet exposure is obvious, and WEBL has performed as you'd expect of a tech-focused ETF over the last couple of months, up 32% over the last 3 days and 90% YTD. The expense ratio is 1.01%, which is more or less in line with all the other Direxion ETFs, and is a pretty cheap price to get leverage. However, the leverage is, of course, conditional given that it isn't straight leverage, it works on daily resets.

Bottom Line

There are some key dynamics that dictate the likely behavior of WEBL over the next couple of months.

• Generative AI is causing a gold rush event where everyone is making initial investments to see if there's a space for generative AI in their businesses. We think that to the extent we can see a generative AI gold rush now in results of companies like Nvidia Corporation (NVDA), it is not an indication of long-term investment trends. Companies have to make sure they're not left behind, and many of them will see business options for AI that they are buying now not become exercised, so there won't be as much follow-up investment. The counterargument is that we are dealing with exponential technologies, and that those should never be underestimated. However, at least as far as ChatGPT goes, while it is an amazing accomplishment, it will not overcome issues like understanding causality, and is ultimately a somewhat regurgitative tool by its very nature - it will displace a lot of commodified white-collar activities, but it's not world-ending. Markets may be extrapolating too much, and there is likely some excess in tech.
• The other thing is longer-term interest rates. Short term rates are already a bit of an issue, since banks across the board are indicating that they are skipping rate hikes for a bit, but not pausing, with the regime still to raise rates. Longer term rates are going to be dictated by longer-term factors like deglobalization, which have a structural effect on inflation, as well as credit market conditions. Credit markets are not great still, and the deglobalization issue is secular, and this all limits how much interest rates can decline. The yield curve is already pricing in relatively higher longer-term rates . However, with substantially higher longer term rates than what markets would have been pricing in 2021 for example, there should be a more meaningful revaluation in horizon values, which drive valuations for tech companies. It's not obvious equity markets are on board with the appraisal of the Treasury markets.

Overall, with Direxion Daily Dow Jones Internet Bull 3X Shares ETF being a 3x leverage instrument, we'd be concerned over making tech bets with the NASDAQ nearing 2021 peak levels. Things are not as good as back then.

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