TECL ETF: Now Worth A Nibble, But Beware Of Risks

Investment thesis: The tech-heavy Nasdaq composite (COMP.IND) is down about a third from its all-time high in the past year or so. With the markets down so much, the inevitable conclusion must be that the time has come to look for buying opportunities. Personally, given the particular market situation, I like the prospects of the Direxion Daily Technology Bull 3X ETF (NYSEARCA:TECL), which offers a 3x amplification of the stock price moves within the fund. A combination of factors, including a pause in interest rate hikes, and possibly prospects of future easing, signs of a global economic recovery starting in the second half of the year, could all be factors that will lead the tech sector to a robust rebound. The prospects of an amplified gain on the back of what might be an already robust market bounce seem like a very appealing, relatively short-term bet in the spirit of the moment.

About TECL

This is a very volatile investment opportunity. The fund declined by about 75% in the past year.

By contrast, the Nasdaq composite has been down by about 35% for the same period. This huge disparity in magnitude of the size of the swings involved is the risk as well as the opportunity.

In regards to the main components of the fund, we are looking at mostly well-established household names, with Apple (AAPL) and Microsoft (MSFT) together making up about 45% of the holdings.

The fund’s expense ratio is just under 1%, which makes it more expensive than most ordinary ETFs, but clearly, the significant swings that one might expect to see in this fund make the expense ratio a bit of an irrelevant factor.

Fed rate hike pause, then accompanying talk of a reverse towards lower rates may be on the horizon

Because the tech sector tends to be a fast-paced capital investment environment, where re-tooling and readjustment of operations, as well as constant R&D spending, are crucial, the cost of money is important to tech stock valuations. It is therefore important for the purpose of timing this trade to do an exercise in educated guessing in regard to when rate hikes may be paused.

A recent emerging factor has been the warmer-than-average weather in the Northern Hemisphere, which has been providing relief to the embattled European economy, which recently went through a divorce from Russian energy. This in turn is lessening the pressure on the US to provide higher LNG export volumes to Europe. Natural gas prices experienced a very significant decline recently as a result.

This should help to relieve some of the inflationary pressures that stem from the energy input factor. With oil prices also below the price levels seen at the start of the Ukraine conflict, we are likely to see a significant deceleration in inflation rates going forward.

While the often-cited year-over-year inflation data shows that inflation is still running high, the month-over-month rate suggests that we have been averaging a rate that is close to the 2% annualized target that the US Federal Reserve considers ideal for some months now.

Given the base-effect aspects of the chart above, as long as month-over-month inflation rates will remain near the current five-month average for the next few months, I expect that the Federal Reserve will find a reason to pause within a few months as the yearly inflation number will start to decline at a fast pace. Given the overall declining cost of hydrocarbon energy inputs in the economy, which I expect to see it last for much of the first half of this year, the low month-over-month increase in inflation should last long enough to push year-over-year inflation rates to acceptable levels in the next few months.

Global economic growth should pick up steam in the second half of the year

It goes without saying that aside from high-interest rates, tech companies also need to worry about weak consumer demand for their products. A combination of factors, including consumers that are increasingly fighting to stay afloat even as they are being squeezed by high food & energy prices, as well as corporate spending being hit by high-interest rates, pushes tech products down the list of spending priorities at both consumers as well as business levels.

There are a few reasons to be optimistic about a global economic turnaround taking place in the second half of the year. First and foremost, there is the return of China finally focusing on economic growth instead of the Zero COVID policy. It may be tough going for them in the next few months as its population goes through what seems to be the most effective way to build resistance to the virus, namely going through the infection, which unfortunately ends up claiming the lives of many people in the process. Looking beyond the next few unpleasant months, China will be able to join the rest of the world in finally embracing a new normal, where people will mostly go on with their normal lives, meaning that the economy will be normalized.

Regardless of whether the war in Ukraine will continue or not, it seems that in that regard the economic impact is already baked into the effects it had on the global economy last year, as well as what it will do to the economy this year. I expect that towards the second half of this year, the economic effects will mostly become regional. In other words, Russia & the EU will continue to be affected, but much of the rest of the world will just move on. Russia’s energy exports have now shifted to Asia, while the EU is left to deal with the after-effects. The same goes with the Russian market, which increasingly becomes a market for Chinese manufactured goods, with the EU companies that used to do much business in Russia now having mostly retreated from that market. The net effect, becomes a net positive for the Chinese economy as well as emerging Russian domestic producers and a net negative for the EU economy, leading to a balancing out in global terms.

Finally, a pause in interest rate hikes in the US and also elsewhere as inflationary pressures seem to be temporarily dissipating should also provide a global stimulus, with the business sector leading the way in increasing spending on growing confidence to borrow. Together with the other above-mentioned factors, global economic recovery is very likely to take shape within a few months, unless some unforeseen factors may come along to derail it. An economic recovery should bring a recovery in global electronics hardware and software demand with it, which should benefit the components of the TECL fund.

Investment implications

Between now and the beginning of the second half of the year, I expect the factors I highlighted above to converge, which should kick off a decent recovery in tech stock prices. The market may act pre-emptively, as soon as the earliest signs of these factors coming together will start showing up on the radar, which is why I decided to take up a small position in the TECL fund, even though at this point I still see relatively strong odds of more downside. If my initial investment will prove to be early in timing, I will use any significant decline in the fund’s share price to add some more, making for an improved average entry point. While this investment opportunity is atypical of what I generally tend to look at, I do believe that the odds of this trade working out this year are pretty high, therefore I decided to act on it.

Risks associated with investing in a leveraged ETF

As I already pointed out, the TECL ETF is down about 75% compared with less than half as much for the Nasdaq index. Generally, this is not meant to be considered a long-term investment option, because it does not retain wealth very well. A case in point is looking at the reverse potential for the market, to previous highs. The Nasdaq composite will need to gain about 60% to reach all-time highs from about a year ago. Even with the 3-time amplification of gains, assuming that the TECL fund would gain 180% for the same period, it will have recovered less than half of the loss. It would need to gain 400% in order to reach the old all-time high.

For further understanding of the risks associated with holding such a fund in one’s portfolio for a prolonged period, I recommend that readers take a look at this educational communication released by the U.S. Securities & Exchange Commission. As I pointed out in the article, this is not a typical investment choice that I tend to look at. It is more of a short-term bet on the market seeing a bounce after a significant decline in tech stocks. I am keeping this bet limited to well under 1% of my total portfolio, which is in part a reflection of my own understanding of the risks involved.