Investors Poured $3 Billion Into a 3x Chip Fund in Two Days. Since June, It's Down 69% While Chips Fell 19%.
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| By Al Qureiyeh |
If you've been tempted to buy the chip sell-off through a fund that promises three times the daily move, you have plenty of company.
Investors put more than $3 billion into the Direxion Daily Semiconductor Bull 3X Shares (SOXL) on Oct. 14 and Oct. 15. Bloomberg reported that the fund was on pace for its best week of new money ever, even as its price kept falling.
By Friday's close, the 3x fund had lost a third of its value in a week. The plain VanEck chip fund fell about 10%.
That gap is the point. A 3x fund is a bet that prices move steadily in one direction, not just on where chips end up. I'd own the chips after this drop, but without the leverage.
What Happened
Chip stocks fell for eight straight sessions through Oct. 16, their longest losing streak since 2008 by the Philadelphia Semiconductor Index, Reuters reported. Bloomberg reported that the rout drew bargain hunters into leveraged funds.
The VanEck Semiconductor ETF (SMH) holds chip makers such as Nvidia (NVDA), Taiwan Semiconductor (TSM) and Broadcom (AVGO), and it fell along with them.
The selling came with two worries. Investors fear that companies borrowing to build artificial intelligence (AI) data centers, such as CoreWeave (CRWV), Applied Digital (APLD) and Nebius (NBIS), can't keep paying their debts. And traders expect the Federal Reserve (Fed) to raise interest rates again in December.
Chip stocks bounced at Monday's open.
On my scorecard, if you skipped CoreWeave when I said to on Oct. 13, you sidestepped a fall of nearly a quarter. If you bought Johnson & Johnson (JNJ) on my Oct. 16 pick, you're ahead of the S&P 500.
We've felt the chip drop too. Taiwan Semiconductor and Nvidia have trailed the market since I suggested them. Both are still rated BUY.
Why the Dip Buyers Are Half Right
More of last week's market commentary was worried than hopeful. The worry is that cheap money for AI is drying up, as Wells Fargo's investment arm put it.
The dip buyers have a point. First, demand for chips is holding. Taiwan Semiconductor told investors on Oct. 15 that it expects fourth-quarter sales to rise from the third, and saw no sign of slowdown.
Second, chip funds have tended to recover. In three of the last four chip sell-offs, the VanEck fund beat the S&P 500 over the three months after its low.
Where they go wrong is the vehicle.
Weiss Rates the Plain Chip Fund a BUY and the 3x Fund a HOLD
Weiss rates the VanEck Semiconductor ETF "B-," a BUY. Its biggest holdings are BUYs too: Nvidia "B+," and Taiwan Semiconductor and Broadcom "B."
The 3x fund rates lower: "C," a HOLD, with a Risk grade of "D+," Weak.
A Weiss Ratings Daily piece on Oct. 18 named five heavily indebted AI cloud companies to avoid, including CoreWeave, Applied Digital and Nebius, all rated SELL. Pieces on Oct. 12 and Oct. 13 warned about AI's circular financing and the cost of replacing AI chips every few years.
I agree the danger sits with the borrowers. A 3x fund carries the same kind of risk, borrowed money, inside the fund.
A piece on Oct. 19 warned that the market is weaker under the surface than the big indexes show. I agree, and that's one more reason not to add leverage now.
Related story: 5 AI Stocks to Avoid: CoreWeave, Applied Digital, Nebius, IREN and Hut 8 Carry Weiss Sell Ratings
A 3x Fund Loses Ground When Chips Swing Up and Down
A 3x fund resets every day. It aims to triple each day's move, not the move over a month, and its sponsor, Direxion, says it "should not be expected to track the underlying index over periods longer than one day."
In a straight fall, it loses about three times as much as the chips. The damage comes when prices swing up and down, because each loss is taken from a smaller base and each gain must rebuild it.
Since chips peaked on June 22, the VanEck fund is down 19%. Three times that would be a 58% loss. The 3x fund is down 69%.
Chip stocks ended about where they started, while the 3x fund lost about a tenth.
The VanEck fund needs to rise 24% to regain its June high. The 3x fund needs to more than triple.
The Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) warn that these funds are "generally not suitable for buy-and-hold investors."
This "B-" BUY Gives You the Chips Without the Daily Reset
Switch from the Direxion Daily Semiconductor Bull 3X Shares (SOXL) to the VanEck Semiconductor ETF (SMH) at the next close; SMH closed Friday at $540.
The VanEck fund owns the same chip makers dip buyers want, without the daily reset. When chips swing, you keep what the chips keep.
Weiss rates it "B-," a BUY, with Reward rated "B+," Good. Its Risk grade is "D+," Weak.
Friday's close was about $64 below its Oct. 9 close of $603, where it stood before this sell-off, by StockAnalysis.com and Yahoo Finance. That's a potential gain of about 12% if it simply gets back there.
The fund pays you very little to wait: one payment a year, a distribution yield of about 0.2%. Give it a year, with the first checks at the Oct. 21 earnings reports and Taiwan Semiconductor's October sales on Nov. 10.
What could work against it: this is still a chip fund. If AI spending is cut, or a Fed hike in December weighs on stocks, it falls with chips.
And if chips rebound in a straight line, the 3x fund would beat it. In the spring rebound this year, the 3x fund tripled while the VanEck fund rose 44%.
The VanEck fund is the kind of idea my process surfaces. If you want ideas tested against a stricter, fundamentals-first screen and tracked for you, that's what my AI Profit Accelerator does.
The Takeaway
What happened: Investors bought the chip sell-off through a 3x fund that lost a third of its value in a week.
What it means: Leveraged funds need prices to move steadily, and since June the swings have cost them far more than three times the chips' loss.
What to do today: Switch from the Direxion Daily Semiconductor Bull 3X Shares (SOXL) to the VanEck Semiconductor ETF (SMH) at the next close; SMH closed Friday at $540.
If chips rebound in a straight line, the 3x fund would win; that is the risk we take.
What We're Watching
First, Oct. 21. Lam Research (LRCX), which sells chipmaking machines, and Meta (META) report after the close. If either cuts its spending outlook, I would sell the VanEck fund, and I will say so.
Second, Taiwan Semiconductor's October sales on Nov. 10. If they fall well short of its outlook, I would sell.
Take care,
AL Qureiyeh
