In a recent article, the author discusses the potential risks associated with leverage in the market, specifically focusing on name stocks like Nvidia (NVDA). The author highlights the dangers of both explicit and implicit leverage, citing past instances of market meltdowns driven by leverage. The author acknowledges the significant role that NVDA plays in the AI revolution, but warns that the excessive leverage in NVDA stock could lead to a potential market collapse, similar to the events seen with XIV in 2018.
The article also delves into the role of ETFs in providing leverage to retail investors, particularly through levered single stock ETFs. These ETFs, designed to track the performance of a single stock with leverage, have become popular trading vehicles for investors seeking short-term gains. However, the risks associated with these ETFs, such as compounding effects and divergent performance from the underlying stock, are often overlooked by retail investors. The SEC’s Market Structure Subcommittee has raised concerns about the complexity and lack of diversification in these levered ETFs.
The author provides examples of levered single stock ETFs that use Nvidia stock as the underlying holding, such as NVDL and NVD2. These ETFs have experienced significant inflows and returns due to the surge in NVDA stock price. However, the author warns that the high volatility of the stock, combined with leverage, could lead to a rapid loss of value in the ETFs, similar to what happened with XIV. The author also explains the mechanisms of leverage used in these ETFs, such as total return swaps and margin borrowing.
The article raises concerns about the potential systemic risk posed by levered ETFs that hold stocks like NVDA, which are significant components of major market indices like the S&P 500 and Nasdaq. The author warns that the influx of money into these indices, driven by both passive and active investors, could lead to a deleveraging episode that affects not only NVDA stock but also the market indices. The author suggests that investors take precautions and reduce risk in their portfolios to protect against a potential market collapse.
In conclusion, the author emphasizes the need for caution in the current market environment, where leverage in single name ETFs and the concentration of high-flying stocks like NVDA in major indices create vulnerable conditions for a systemic shock. By being aware of the risks associated with leverage and taking steps to mitigate them, investors can protect their portfolios from potential market turbulence and preserve their investments in the long term.
