The banking sector has been the main topic of conversation in the past few days in the equities market. With the fall of Silicon Valley Bank’s parent company (SIVB), bank stocks have taken a nosedive. Clearly pushed by bearish momentum, the SPDR S&P Bank ETF (KBE) has shed 20% of its value in only a few days.
To some, this may seem like a perfect opportunity to jump on the bandwagon and bet against the banking sector. One way to go about doing so aggressively is to own shares of Direxion Daily Financial Bear 3x Shares ETF (NYSEARCA:FAZ), up 10% for the day as I write this sentence and higher by 30% over the past five trading days.
But I believe that a bet here is much more likely to cause pain than to create gain opportunities, except for the few traders that are lucky enough to get the entry and exit timing right. Below, I explain why.
FAZ: long-term pain
The Direxion Daily Financial Bear 3x Shares ETF is a triple-leveraged play against the performance of the Financial Select Sector Index. A quick way to think about it is to look at the top holdings in the index: Berkshire Hathaway (BRK.B) (BRK.A), JPMorgan (JPM) and Bank of America (BAC) represent nearly one-third of the index’s exposure. Owning FAZ implies a triple bet against these and similar companies and stocks.
FAZ is a very liquid but pricey ETF with a net management fee of 1.09% that has been nearly four times as volatile as the S&P 500 since the 2008 inception. Throughout this period, the fund returned an annualized loss of 55%. You’ve read it right: FAZ has turned $1,000 into a single penny over the course of the last 15 years.
The outsized losses can be explained by a few factors. First, but not even most importantly, bank stocks have performed well in the last decade and a half, so being short has not panned out. But also, leveraged ETFs are exposed to volatility drag: the more volatile the share price, the more a fund like FAZ will “bleed” as it resets its exposure to the underlying assets on a daily basis. If considering an investment here, read more about this subject from FINRA and the SEC.
Despite the terrible long-term track record, notice that FAZ did particularly well during the thick of the Great Financial Crisis (chart below), when the ETF climbed nearly 150% between inception and September 2008. This sort of performance speaks to the real (and probably only) benefit of owning FAZ: to profit greatly from bearish short-term movements in the price of bank stocks.
Avoid the trap
The ETF’s intense volatility alone is enough for me to consider FAZ a likely trap today, even though the banking sector remains under the spell of the bears. Owning shares is like trying to swim upstream to the peak of a mountain: you may succeed for a moment (short-term gains, maybe), but you will eventually get dragged out to sea (nearly guaranteed long-term losses).
The second reason was also hinted at above. FAZ’s bearish bet is against well-established, in many cases highly diversified financial institutions. The smallest company by market capitalization within the top 10 holdings in the Financial Select Sector Index is BlackRock (BLK), at a market value of $94 billion.
Companies of this caliber are very unlikely to face some of the same issues that has hit the more specialized, in some cases regional banks that are at the epicenter of the current banking crisis. If anything, and assuming no widespread contagion in the system, the megabanks may benefit from the challenges faced by their counterparts as investor money seeks safe havens.
It may be counterintuitive and maybe contradictory to be bearish FAZ, as I am today, and to also have a sell rating on the Direxion Daily Regional Banks Bull 3X Shares (DPST). In fact, in the short term, one is very likely to produce positive returns while the other digs deep into a loss position – although it is nearly impossible to tell today which one is which.
But in the longer-term (and I am talking a few months, not even years), both triple-leveraged ETFs are strong candidates to inflict pain on investors who hold their shares for any more than a few days, at best. Therefore, I believe that FAZ is a sell.