In a piece I published last week in this forum (here) I mentioned how the availability of explicit leverage to some, but not to all, has frequently resulted in the tendency for all participants to move off an optimal portfolio into increasingly risky securities. My conclusion was that similar to the dynamics of pre-global financial crisis speculation in implicitly levered “synthetic asset-backed securities”, as well as the pre-XIV-meltdown dynamic (XIV was the inverse volatility ETF which erased all of its value in roughly a day in 2018 in an event known as “volmageddon”) in 2017, we might be in another period of deleveraging driven meltdown; this time arising from explicitly and implicitly levered positions in name stocks such as NVDA, and many others.
To be sure I do think that the AI revolution is more real this time than in past eras and NVDA is at the forefront of this round; NVDA is the “picks and shovels” provider with pricing power this time. I am a big admirer of the company. But the stock and its legions of fanatics tempted with the ability to lever is another matter. The impact of leverage and market dynamics on price and feedback loops on stock prices cannot be ignored. I have no idea if the fair value for this stock is $200 or $2000 (current price about $900 – Source: Bloomberg). But what I would like to highlight is just like the two other episodes mentioned above, the massive retail inflow into NVDA both through short-dated call options and levered ETFs is providing both explicit and implicit leverage to investors who have wholeheartedly taken advantage of it. And this leverage is primed to unwind, possibly dragging bystanders in index funds with it.
The full note on this important topic can be downloaded at this link: LTA Thinking – Levered Single Stocks ETFs on NVDA