TECS: How to take advantage of this August if technology collapses

0

Thomas Barwick/DigitalVision via Getty Images

Thesis

Direxion technology bears 3x actions (NYSEARCA:TECS) is an ETF belonging to the category of leveraged funds. The vehicle seeks daily investment results 300% of the reverse performance of the Technology Select Sector Index. When the index sells significantly like in 2022, TECS expects outsized gains. We believe that leveraged funds like TECS should be used as trading instruments rather than buy-and-hold vehicles, with distinct holding periods and objectives in mind. We view TECS as an effective capital allocation tool for investors who have sector views for defined time periods. For example, a retail investor constrained by their brokerage balance but with a bearish tech view at the start of 2022 could have used TECS to gain exposure to $300 of capital by investing only $100.

We don’t think the stock and tech downturn is over. In our view, there could be another -10% leg in the market before we can call it a sellout. This vast market movement should translate into another +30% for TECS. More importantly, we don’t believe there will be a V-shaped recovery in the tech sector. Like Credit Suisse‘s Zoltan Pozsar, we believe instead that we will see an L-shaped recession, which will provide the best “medicine” to fight inflation. We believe inflation has reset to a permanent higher level and higher rates are here to stay. It will take a long time for inflation to come down to a more acceptable level:

bofa

Expected inflation (BofA)

Courtesy of Bank of America, we can see that even if the CPI moves to 0% month-over-month change, inflation will be nowhere near the 2% threshold by the end of the year, when the forward SOFR curve implies that rates will peak:

discuss

SOFR Curve (Chatham)

Indeed at 0% CPI M/M it will take us at least 1 year for the figures to come down to historical levels. Are we even expecting a 0% CPI month after month? No.

Our view is that rates will stay high for longer this time around and that the Fed is committed to seeing inflation figures come down substantially before cutting rates, even at the cost of a mild recession. Technically, we are in a recession as we speak, with two quarters of contracting GDP numbers. However, the labor market is strong, consumer balance sheets are healthy, and the political apparatus is quick to point out that it really isn’t a recession when “Help Wanted” signs abound. This macro setup results in higher discount rates and lower valuations for technology companies.

We believe the market rebound in July was the result of oversold conditions from June and we will resume the decline in this bear market. The catalyst for tech outperformance that we saw post-Covid, namely zero rates, is no longer there, and will in fact be a headwind going forward. Rates will stay higher for longer in today’s inflationary environment. An active and sophisticated investor can take advantage of a potential -10% decline in tech stocks through the leveraged TECS vehicle and realize a 30% return if that view materializes.

Performance

The fund is up more than 22% since the start of the year:

alpha

Cumulative performance since the beginning of the year (Looking for Alpha)

Being a leveraged fund, TECS does not have a robust long-term return profile:

Three

Performance 3 years (Looking for Alpha)

The vehicle is down more than -97% on a three-year basis. 3x leverage on daily moves during a structural tech bull market will do that to you. TECS is a trading tool to be used by active investors with very short timeframes. A buy and hold investor should not consider this instrument.

But if we go back to the chart since the beginning of the year, we can notice a very interesting performance indicator: the TECS was up 100% earlier in the year, before the market rally in July. There is also a basis between the XLK performance since the beginning of the year and the TECS performance which is not multiplied by 3 by the XLK performance for the year. This brings us back to our discussion about the ETF trying to replicate the daily movement of the index three times. The fund fact sheet is very simple in disclosing this basis:

These leveraged ETFs target a return equal to 300% of the return of their benchmark for a single day. Funds should not be expected to provide three times the return of the benchmark’s aggregate return for periods longer than one day.

Conclusion

TECS is a leveraged ETF that provides an investor with daily investment results equal to 300% of the inverse performance of the Technology Select Sector Index. An investor who wants to short the technology sector in a capital-efficient way can use TECS to gain exposure to $300 notional for every $100 used. We believe July’s strong rally in high beta and oversold stocks was the response to oversold technical levels and we will see a structural bear market rally in this sector in August. We believe that the fight against inflation is far from over and that rates will have to stay higher for longer than expected by the market. As a leveraged vehicle, TECS is an excellent short-term trading tool to take advantage of the next leg down. We expect another -10% in the index on the next leg down, which translates to around +30% performance for TECS.

Share.

Comments are closed.