In a recent article, the author discussed the potential risks associated with the availability of leverage in the market, particularly in the context of NVDA stock and other high-flying securities. He highlighted the role of leverage in driving market dynamics and the potential for a deleveraging-driven meltdown, similar to past episodes involving leveraged securities such as XIV. The author emphasized the importance of understanding the impact of leverage on stock prices and warned investors to be cautious in light of the current market conditions.
The author raised concerns about the use of levered ETFs, which were originally designed to provide exposure to broad market indices but have been increasingly used to offer leveraged exposures to single stocks. He pointed out the risks associated with these vehicles, particularly for retail investors who may not fully understand the implications of leverage and daily rebalancing. The author cited a report from the SEC Investor Advisory Committee highlighting the complexity and opacity of single stock ETFs and the potential effects of leverage on their performance over time.
A search for levered single name ETFs using NVDA stock as the underlying holding revealed a number of options, including NVDL, NVD2, NVD3, 3LNV, and NVDU, among others. The author noted the significant returns and market capitalization growth of the largest levered NVDA ETF, NVDL, as NVDA stock soared in value. He also discussed the mechanisms by which these ETFs use leverage, such as total return swaps and margin borrowing, to provide investors with leveraged exposure to the underlying stock.
The author expressed concerns about the potential systemic risks posed by leveraged ETFs on high-flying stocks like NVDA, which are heavily weighted in major market indices. He highlighted the mechanical nature of passive investing, which requires funds to allocate a proportionate amount of assets to these stocks based on their weight in the index. The author warned that a deleveraging episode could be triggered if any of the pre-conditions for continued leverage and market growth were violated, leading to a vicious cycle of selling and potential contagion in the market.
In light of these risks, the author advised investors to consider reducing risk exposure and adding protection to their portfolios. He emphasized the need for caution and vigilance in the current market environment, where the presence of leverage in single stock ETFs could magnify the impact of a potential market shock. The author suggested that hedging against systemic risks could be a prudent strategy for investors looking to safeguard their portfolios in the face of increasing market volatility and uncertainty.
