ProShares UltraShort QQQ ETF (NYSE: QID) is a bearish leveraged ETF on Invesco QQQ Trust (QQQ).While leveraged ETFs are highly risky and must be considered carefully, the fact is QQQ has almost always been trading high despite the much higher cost of capital we think it can afford, which is unusual even with AI optimism. We don’t see any upside for QQQ and the catalyst is continued failure to address the last leg of inflation.
Things to note about leveraged ETFs
Because in the case of QIDs they are reset every day after mimicking the change in the index for that day, there is a problem of value erosion. While a 1% rebound after a 2% decline is not bad, a 6% decline and a 3% rebound is not just a matter of accumulation.have The reason for Warren Buffett’s first rule is, don’t lose money. If you lose money, your ability to recover is reduced, meaning that with every dip, you need a larger recovery percentage to get back to step 1. If an asset drops 33%, you would need nearly 50% to recover. If an asset drops 50%, it will need to recover 100% to break even. Even if the next day’s rally is bigger than the previous day’s loss, with leveraged ETFs, even if the rebound doubles, it still doesn’t help much because more money was lost the day before. Due to the dynamic nature of daily resets, you also cannot rely on fundamentals to return to previous levels to recoup your investment. It is also unlikely that you will fully recover your investment if expectations for the ETF’s underlying factors return to previous levels against you.
If you do not fully understand these risks, do not proceed with purchasing leveraged ETFs. They are best used in the short term due to value erosion. They are highly speculative emergencies instruments.
Reference links for these risks:
The QID parameters can be elaborated as follows:
- Capital costs are currently high. Due to the inflated horizon values inherent in high multiples and high-expectation stocks, technology company valuations should be more sensitive to interest rates than is evident in the market.
- This means that those stocks in the technology index that can benefit from artificial intelligence have high expectations for artificial intelligence. This includes computing power, computing hardware, and of course the AI developers themselves. Expectations for this growth may also be overstated simply based on the dynamics of new technologies, especially since much of the demand now may be that companies are simply paying the proverbial “premium” for AI options in their businesses, and AI is not Suitable for all these businesses.
- With QQQ at almost all-time highs, the expected cost of capital is likely that interest rates will soon fall more or less sharply back to pre-COVID levels before impacting those deep values through the discounting effect. The yield curve and the bond market where the smart money is located absolutely do not bear this out. Long-term rates are actually the rates that have revised upward the most. While this is a good sign for the demand side of the economy, it is a major problem for technology valuations, which were already quite high even at pre-COVID costs of capital.
- Given the great difficulty that may be encountered in eliminating the last stretch of inflation, adjustments in long-term interest rates make sense and may be and are already expected if inflation persists. Energy inflation isn’t helping either, and countries with vested interests in the U.S. economy have significant control over oil prices. This last leg has proven disappointingly stubborn in recent CPI reports.
QID lets you get this fancy daily reset lever pretty cheaply, which is a bonus. The expense ratio is less than 1%. We believe the issue with extending QQQ is well justified by fundamentals, where the stock market is out of step with the bond market and priced at benchmark rates. We think QQQ is unlikely to have more upside, while QID could be interesting.
However, we don’t like leveraged ETFs without a clear catalyst. We don’t know how the market will react to the next CPI report. Holding a leveraged ETF for the long term and letting temporary changes impact it could expose your holdings to value erosion. QIDs can only be considered very close to key economic releases. We won’t consider this until mid-November, when the next CPI or non-farm payrolls data for early November is released, which could help revise expectations.
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