Exchange-traded funds have been rapidly swallowing more and more of the stock market. Inflows from investors in the U.S. have soared over the past decade by some $1.7 trillion and continue to see money coming into new and existing exchange-traded funds by some $12,000 per second. This has resulted in 30% of all trading on stock exchanges being done through ETFs (as measured by the value of the funds).
All of this comes as financial marketing machines are turning out all sorts of ETFs and continue to bang on about how great they are for all investors. And obviously, by the numbers, the machines are winning in grabbing cash. Now there are plenty of things to be wary about with ETFs. After all, most investors think that when they buy an ETF that they are buying and owning a basket of stocks and other securities like a mutual fund.
But really, when you buy an ETF, all that you’re getting is an IOU from the issuer that’s tied to a litany of securities, both actual and synthetic that are cobbled together in the dark world of financial engineers at various investment banks and trading houses. This, of course, is a hard lesson to learn when markets don’t always trade in orderly ways causing prices for ETFs to vary wildly away from where they’re supposed to be relative to their stated index missions.
A recent class-action lawsuit in California over how a series of Blackrock iShare ETFs plunged in 2015 was unsuccessful due to BlackRock proving that the investors were not able to tie their claim to actual registered underlying securities only amplifies the underlying systemic risk in the derived security investments for individual investors.
But, the market moves on and money keeps coming in the doors of ETF purveyors. However, just because an ETF pitch may sound like a great call, the marketing machines have and will continue to pump out ETFs that you should run away from and here are five that should be fled right now.
Frightful ETFs to Flee: SPDR S&P Oil & Gas Equipment & Services ETF (XES)
The SPDR S&P Oil & Gas Equipment & Services ETF (NYSEARCA:XES) is as its name implies, an ETF that tries to track the U.S.-listed companies that provide drilling and related goods to the oil and gas industry. And for much of that industry, this has been a tough market. And it shows in the ETF’s returns. It’s down nearly 25% year to date, down some 25% over three years, down over 12% over five years and down nearly 8% over the past ten years.
That means that for those in this ETF, it’s been more than painful. And worse, as the simple S&P 500 index has churned out positive returns for the same periods of time.
The oil and gas market is in a glut in the U.S. And that glut is shared on the global petroleum market. Crude remains in the low $50 range and natural gas has struggled in the $2 to $3 range barely making it profitable for many existing fields let alone new exploration.
This has resulted in a plunge of oil rigs in the U.S. down some 55% from this time in 2014 to only 750 rigs. And off-shore there’s a glut of existing rigs with only 22 currently in operation. And the trend is now hitting the shale fields with the third quarter showing only a minor uptick in rigs by 6% vs the steady quarterly increases averaging around 20% for the prior four quarters.
So, if you’re a company in this business, it’s cut-throat competition in price and service just to stay in business. That’s not a compelling draw to invest. And sure, plenty of folks might be hoping for sustained higher petroleum prices — but with so much overcapacity, the market for equipment and services will need a whole lot more demand just to begin to turn the corner.
Frightful ETFs to Flee: Direxion Daily Semiconductor Bear 3X ETF (SOXS)
The Direxion Daily Semiconductor Bear 3X ETF (NYSEARCA:SOXS) is an ETF that synthetically tracks the inverse performance of leading semiconductor company stocks inside the Philadelphia Stock Exchange Semiconductor Index. Not only does this ETF attempts to track the inverse of the index, it goes further by leveraging the inverse tracking by 300%. So, if the index goes up 10%, the ETF should lose 30%.
That’s been a bad bet with investors in this ETF losing some 60% alone year to date and the bleeding has been a trend with losses being quite consistent over the past one, three and five years of similar or worse losses. Think about the market for semiconductors or “chips”. Every gadget from the latest mobile phone to every tablet has chips and the demand continues with everyone wanting or needing to have the latest new-new thing.
And sure, there have been some chip makers like Toshiba Corp (OTCMKTS:TOSYY) that had to sell their business. But Toshiba’s troubles came not from chips, but it follies in the nuclear power plant business. And bidders for its chips unit were fast and furious from it competitors and its customers.
In order to see a miraculous turnaround for this ill-fated ETF, you’d have to see a massive reversal of demand for electronics on a global scale that would need to see the rise of the Luddites shunning any new innovation.
Frightful ETFs to Flee: Direxion Daily Regional Banks Bear 3X ETF (WDRW)
The Direxion Daily Regional Banks Bear 3X Shares (NYSEARCA:WDRW) is a big bet that U.S. regional banks are headed for Armageddon. The ETF invests primarily in synthetic and derived securities structured to track the inverse performance of the Dow Jones Select Regional Banks Index as opposed to the market standard KBW Nasdaq Regional Banking Index.
But if that isn’t bad enough for investors buying this ETF, it is internally leveraged in its securities to perform three times the inverse of its tracked index. That has resulted in losses so far this year of over 25% and for the trailing year by more than 66%. And for those masochistic investors holding this for the past five years have endured losses of over 84%.
And it should get even worse in the months to follow. First, banks in the U.S, are faring better and better. The Federal Reserve Bank has been largely steady in its targets for Fed Funds creating less uncertainty for banks asset and liability folks. And even with the unwinding of the trillions of dollars in its bond-buying program, the market continues to see a very limited amount of bonds coming to the market. And if anything, the minor impact on the yield curve might well favor banks’ new lending portfolios with slightly higher yields for longer-term loans.
Second, regional banks are seeing the benefits of the new administration and its view on regulation. Bank lobbyists are pushing for and receiving easier reviews from Federal and state regulators as a boon for the U.S. economy. And with the new Fed’s Vice Chair for regulation appointed and confirmed, Randal Quarles is expected to be the ultimate banker’s friend when it comes to enforcing Fed rules.
Third, with the U.S. economy expanding regional banking lending in projects from infrastructure to construction will continue to rise adding to profitability. And the built it and buy it in America push can only help regional banks. And regional banks in rural America should also be beneficiaries of USDA expansion of rural development spending.
Regional banks make for a great bet, the Direxion Daily Regional Banks Bear 3X ETF continues to be a pitiful punt.
Frightful ETFs to Flee: Guggenheim CurrencyShares Japanese Yen Trust ETF (FXY)
The Guggenheim CurrencyShares Japanese (NYSEARCA:FXY) ETF is structured to invest in derived securities that are structured to track the price movement of the Japanese yen against the U.S. dollar.
And that’s been a minor success so far this year seeing a little gain of some 3%. But that pales in comparison to how the ETF has performed for the trailing twelve months losing over 8% and a whopping loss of nearly 32% for the past five years. Moreover, the yen has a litany of challenges that should result in not only wiping out that minuscule bounce but a continued downward march against the dollar.
At the top of the list is the near to negative short-term interest rates. This means that traders and investors from private equity to hedge funds continue to use the yen as a funding currency. By borrowing or swapping yen investors can in effect borrow at a near zero or negative interest rate and use the proceeds in higher performing assets or higher-yielding currencies.
And with the economy while up in some sectors seen as fragile, particularly in the vital retail sector, the Bank of Japan has little to no room to direct interest rates higher.
Meanwhile, U.S. and many other markets are already posting somewhat higher yields even if modestly, but that’s all it takes to make shorting the yen a worthwhile and risk-controlled bet. Good for those selling the yen, bad for those investing in this ETF. And even with many Japanese corporations faring better in their earning, much of that is credited with the cheaper petrol and natural gas prices reducing. And even more to the fall in the yen over which has resulted in foreign revenues generating high net income in yen terms.
And households remain cautious as economic fear pervades throughout the economy, amplified with a lack of wage growth. Then there’s the mess on the Korean peninsula and missiles flying about and over the islands of Japan. Not the best case for Japanese economy and for the yen.
Frightful ETFs to Flee: Direxion Daily Russia Bear 3X ETF (RUSS)
The Direxion Daily Russia Bear 3X Shares (NYSEARCA:RUSS) is an ETF that like some of the other Direxion bear or inverse ETF that invests in derivative securities that are structured to track the opposite movement of an index. In the case of the Russia Bear ETF, the fund targets the opposite of the DAX Global Russia Index.
And with the 3X in its name, the ETF leverages its positions to move in the opposite direction of the leading Russian stocks by three times. So a bet against the Russian market gets multiplied. And that’s a real problem for this ETF with it generating a loss of over 24% so far this year. And for the trailing twelve months, it lost 53% and over 93% for the past five years.
You would’ve thought that a bet against the Russian market would’ve been a pretty good bet. After all, Russia is facing some pretty significant challenges. First, the nation has a litany of economic and trade sanctions being levied against it over various accusations of military and other adventures.
And second, Russia and its markets and economy are very dependent on oil and natural gas which continue to be down in value from past peaks resulting in a dramatic loss of revenue for Russian companies and the government. So, on the surface, these should be bad for stocks and good for an inverse tracking ETF. But Russia has turned the tables on its challenges.
It has become very self-sufficient when it comes to its food, consumer and industrial goods. This has resulted in local companies generating larger gains in their sales inside Russia. And even the petroleum sector continues to improve, particularly with a mild bump up in crude prices in cooperation with OPEC nations particularly with a renewed relationship with Saudi Arabia.
And the Russian government was prepared. Typically in the past when Russia had economic strife it would spend heavily to support the Russian ruble. But over the past three years, it has allowed the ruble to float and fall. This has had a great positive impact on the economy. First, it has limited outbound spending by Russians on travel and foreign purchases — redirecting that spending domestically.
And its exports, where and when allowed, are resulting in gains in ruble terms and greatly improved margins, particularly in crude and natural gas exports. The net result is that the market for leading Russian stocks continues to be a very positive with local indices up more than 40% over the past five years. Like the nation or not, Russia is proving resilient and the markets prove it. This makes an ETF bearish bet on Russia a bad one.
As of this writing, Neil George did not hold a position in any of the aforementioned securities.