Sometimes They Really Do Ring a Bell
5X-Leveraged ETFs are the latest Wall Street innovation destined to end badly
I’ve always believed the old Wall Street maxim that they never ring a bell at the top of a bull market.
And then I saw this come across my screen this morning:
On second thought, maybe they do ring a bell at the top.
This isn’t an internet spoof. It’s real.
I’m a big believer in allowing people to take risks and to enjoy the payoff (or suffer the loss), so long as they’re not hurting anyone other than themselves.
But I also cannot think of any legitimate use case for a 5x leveraged ETF on a single stock. This is degenerate gambling.
And again… I’m 100% comfortable with degenerate gambling. It’s not my thing, but we live in a free country and if a person wants to blow their net worth at the craps table, that’s their business.
However…
It’s not not hard to imagine this going very badly. Excessive leverage via financial derivatives has a way of spilling over into the underlying assets. There is a reason why Warren Buffett referred to them as “financial weapons of mass destruction.”
I’m not saying that a handful of 5x-leveraged ETFs is going to blow up the world economy like mortgage derivatives did back in 2008. They won’t be nearly big enough to inflict that kind of damage.
But they do have the potential to destabilize the most expensive and heavily concentrated stock market in history. And if nothing else, they point to the kind of disregard for risk that you see at major tops.
Does this mean the bear market starts tomorrow?
Of course not.
But does this suggest you should have one foot out the door, metaphorically?
Yes.
You should have hedges in your portfolio.
You should be taking profits and rebalancing the stock portion of your portfolio.
And you should strongly consider dialing back your risk at least a little and having a little extra cash on hand.
As for the 5X ETFs, I’m never going to tell a trader not to trade. If you want to play with them, play with them. Just remember that leveraged products like these are designed to be ultra-short-term trading instruments. They’re not designed to buy and hold.
Regards,
Charles Lewis Sizemore, CFA