Why Direxion Daily Semiconductor Bull 3X ETF Crashed Today
Key Points
The 3x leveraged ETF did exactly what it's designed to do, tripling the sector's losses.
Leveraged ETFs carry hidden costs that can erode returns over time, even when the sector performs well.
Days like today show why leveraged ETFs work better as short-term trades than long-term holdings.
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Direxion Daily Semiconductor Bull 3X ETF (NYSEMKT: SOXL) has been a market-beater in recent years, but it was a different story today. The exchange-traded fund (ETF) highlighted the downside of leveraged funds, falling as much as 20.9% at 1 p.m. ET as investors rotated out of lofty valuations in the chip sector.
Why semiconductor stocks tanked on inflation news
The Direxion Daily Semiconductor Bull 3X ETF is a leveraged ETF, which uses options and other accounting tools to triple the daily return of the NYSE Semiconductor Index. The iShares Semiconductor ETF (NASDAQ: SOXX), which simply owns shares reflecting the same index, fell as much as 7%. So the leveraged fund is doing exactly what it's supposed to do, for better or worse.
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Weak economic data like this report can undermine high-flying stocks and ongoing bull runs, as investors expect reduced access to low-cost loans. That's bad news for businesses seeking funding for their growth-boosting projects, but also for some of the investors who seek higher rewards with risky margin investments.
The fund's 10 largest holdings all trended lower today, due to a disappointing inflation report. Top holding Nvidia (NASDAQ: NVDA) is only down by 0.5%, because the chip designer's customers are building AI data centers with or without low-cost loans. But Micron Technology (NASDAQ: MU) is down by 6% and Qualcomm (NASDAQ: QCOM) dropped 15%, because they have more exposure to cost-sensitive consumer markets, and Micron is investing billions of dollars in additional chip-making facilities. Nvidia dodges these issues by relying on third-party manufacturing services and enterprise-class clients.
Image source: Getty Images.
Leveraged ETFs are fun until they aren't
Days like this will remind you of the downside found in leveraged ETFs. Due to lofty expense ratios and hidden costs, the 3x Direxion fund hasn't even doubled the non-leveraged iShares Semiconductor ETF's returns over the last five years. And thanks to the increased risks of inherently volatile returns, many leveraged ETFs go out of business in the long run. They aren't equipped to handle long downturns in their chosen sectors.
So you may want to dabble in leveraged ETFs, but they are not a stable foundation for a diversified nest egg. Today's message was brought to you by the number 3 and the letter X.
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Anders Bylund has positions in Micron Technology and Nvidia. The Motley Fool has positions in and recommends Micron Technology, Nvidia, Qualcomm, and iShares Trust-iShares Semiconductor ETF. The Motley Fool has a disclosure policy.
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