SOXL: Heightened Interest, Leveraged Problems

Investment (Sell) Thesis

The Direxion Daily Semiconductor Bull 3X Shares (NYSEARCA:SOXL) ETF offers a three-fold daily exposure to the ICE Semiconductor index, encapsulating 30 US-listed semiconductor companies, making it a tempting tool for those bullish on the short-term outlook of this sector​​. However, its inherent leverage, coupled with a semiconductor industry grappling with high valuations amidst higher interest rates, casts a shadow on its appeal. While this leveraged ETF has performed well since its inception in 2010, much of this has to do with the parabolic nature of semiconductor stocks over the last 13 years, especially since 2015. The underlying mechanics of this ETF (its high leverage) can create catastrophic performance in a down year. Even short term sudden drops can severely hurt investors given its leveraged position. While this ETF can, and has done well in upward trending markets, I believe we are heading towards volatile markets ahead. Volatility is a leveraged ETFs worst nightmare due to its daily resetting statistics.

This is a sell simply because its full of risks in my opinion. There are better ways to make money.

Introduction

The semiconductor sector witnessed a significant boom post-2020 pandemic, fueled by surging demand amidst supply chain disruptions. SOXL rose with many of the semiconductor stocks in the 2010s up until 2022, creating a return greater than 10,000%.

However, 2022 marked a downturn as many semiconductor stocks suffered due to weakening demand and downward revisions in revenue growth, translating to shrinking profit margins.

Last year, the SOXL ETF lost almost 86% trailing the S&P 500 in what was already a bad year for stocks. This was due to the leverage, which means that the ETF seeks to mimic 3x daily exposure to a modified market-cap-weighted index of 30 US-listed semiconductor companies.

Like I mentioned before, this is great when Semiconductor stocks are going up, this was not the case last year.

This year, semiconductor performance has been better, with stocks like Nvidia (NVDA) up almost 183%, Intel (INTC) up almost 33%, and Advanced Micro Devices (AMD) up over 50%.

With this you’d think SOXL would be up well over 100% given the 3x leverage right?

Not exactly.

SOXL is up 61.32% Year to Date. Still an amazing return, but less than 3x the average return of some of the stocks above.

Why? It’s harder to regain a certain high, the lower a stock (or leveraged ETF goes). This is because losing 50% means you have to gain 100% to get back to break even, the more below this the harder it is to recover.

SOXL lost 86% last year. That’s hard to come back from.

In addition, leveraged ETFs tend to generally decay anyway. This has been a hard trend that SOXL managed to successfully fight till 2022. But even just one bad year hurts that and damages the bigger picture.

Catalysts to Watch

While recent legislative endeavors, notably the CHIPS and Science Act, which allocates $280 billion for domestic semiconductor R&D and manufacturing, present a positive outlook for the sector​, recent bans on computer equipment and semiconductor sales to China could hurt revenue (and therefore share price) of US Semiconductor firms. While Nvidia has come out and said they have enough demand to likely offset this, other chip firms may not be as lucky.

Leveraged Risks

The leveraged nature of SOXL amplifies both gains and losses, a feature that, coupled with daily resets, leads to a compounding effect when held over multiple periods, necessitating a bullish short-term outlook for profitability​​. The high valuations of semiconductor companies, despite declining revenues, pose a significant risk. Moreover, the global nature of the semiconductor industry exposes it to geopolitical tensions and trade disruptions which could adversely affect the industry’s performance.

Where I Could Be Wrong (What’s the Bull Case?)

Leveraged ETFs tend to do best in strongly trending markets like we saw in 2020 and 2021. In those environments, the SOXL ETF was up 67% in 2020 and 118% in 2021, respectively. These are impressive gains for anyone (myself included, I envy these). But they were built on an industry facing lower interest rates than now, and different fundamental factors impacting it (see below).

While we could see Semiconductor stocks rally into the year close, I’m not sure this is likely. Recent chip sale bans by the Biden Administration, risks of supply chain disruptions related to conflict in the Middle East and potentially Taiwan, (the industry would implode if there was a war), all remove the fundamental strength to power the stocks that make up this ETF.

Coinciding with potentially fundamental instability, market volatility and instability is a leveraged ETFs worse nightmare. With leveraged ETFs, price action resets daily. This can cause a negative compounding effect. In volatile markets, this is amplified, often destroying investors principal. Markets that oscillate obliterate shareholder returns.

This is why SOXL has not nearly recovered to 2021 highs even though stocks like NVDA are higher than they were in 2021.

Additional Insights

Recent data indicates an increased ETF inflow for SOXL, highlighting a possible renewed interest or speculative behavior among investors​​. Investors have been noted to game with leveraged ETFs near market peaks as large price swings can cause rapid movement in share prices. If this last summer was the local peak, investors should watch out for what comes next.

Conclusion

The SOXL ETF is a high risk proposition for investors bullish on the semiconductor sector’s short-term outlook, especially riding recent AI hype. Given, the inherent leverage, daily reset mechanism, and the industry’s susceptibility to global disruptions means you are often fighting the tide holding this ETF for any notable period of time. The contrasting performance of SOXL in 2021 and 2022 underscores the volatility and the risk-reward paradigm investors must navigate. Given I am a long term investor (not a day trader) this certainly feels like something any investor looking to make real returns should avoid. We all want stocks that multiply in value. While this ETF has since 2010, we can look back at performance in 2022 to know those gains were not sustainable, and that this is not a long term place to park an investment.