ETF lending activity sheds light on market dynamics

As changes in geopolitical risk, volatility, and monetary policy continue to influence financial markets, a number of these key themes are seen in ETF securities lending activity.

Over the past month, financial markets have navigated several events which were not present in the first half of the year. Central bank interest rate policy divergence has become a reality, there have been increased levels of geopolitical risk due to rising tensions in the Middle East and political changes have affected all of Europe. In addition, there have been new developments in the US presidential race and an increase in market volatility, which has recently caused the Cboe Volatility Index (VIX) to post its biggest intraday jump on record.

The rapidly changing financial landscape, many of the recent themes impacting the markets have also been seen in ETF securities lending activity. The The increasing use of ETFs to capture investor sentiment and hedge portfolio risk worked to the benefit of ETF lenders as securities lending proceeds for both June and July 2024 saw a positive year-over-year growth (June revenue +26%, July revenue +19%) – one of the only asset classes to do so.

Interest rate policy and recession risk

In early March, lending activity in the iShares MSCI EAFE ETF (EFA) began to pick up, peaking at the end of May, just before the European Central Bank began cutting interest rates. This ETF tracks the MSCI EAFE Index, which focuses on developed markets outside the US and Canada. The borrowing and subsequent shorting of this ETF has allowed investors to hedge against a number of different economic circumstances that have recently occurred in the global economy. Some of these scenarios include currency depreciation against the US dollar, interest rate differentials and central bank policy divergence, strong US economic growth and the potential for a market correction after a period of rising equity valuations.

Bearish on the return of mega-tech

The GraniteShares Nvidia 2x Long Daily ETF ( NVDL ) aims to generate twice the daily percentage change of NVIDIA common stock ( NVDA ). The recent market sell-off, centered around large tech stocks, has driven NVIDIA’s stock price down from $135 per share in early July to just under $100 per share in August, a 35% decline. As a result, shorting volume of the GraniteShares Nvidia 2x Long Daily ETF has been seen to increase as investors remain bearish on the full recovery of the company’s share price. A slowdown in gains in the AI-related technology sector and a deleveraging following a recent rise in Japanese interest rates have been cited as possible reasons why the prices of major tech stocks may struggle to return to their previous highs.

Other large tech ETFs, including the ProShares Ultrapro QQQ ( TQQQ ) ETF, also saw an increase in lending activity. This ETF seeks daily investment results that correspond to three times the daily performance of its underlying benchmark. The fund invests in 100 of the largest domestic and international non-financial companies listed on the technology-focused Nasdaq stock market based on market capitalization. By shorting this stock, any move lower in the benchmark will be amplified threefold. Therefore, this increase would suggest bearish investor sentiment following the recent sell-off in the large tech sector.

Geopolitical risk intensifies as conflict escalates

Over the past month, lending activity has surged to all-time highs in the iShares MSCI Saudi Arabia ETF (KSA). While there are many reasons an investor might borrow this asset, the growing conflict in the Middle East and the large allocation this ETF has to regional oil producers may suggest bearish sentiment toward any imminent resolution of the regional conflict and any future improvement of important commodity prices.

ETFs have become essential tools in both hedging and investment strategies due to their flexibility, liquidity and diversity. Their importance as an asset class continues to grow because they allow investors to flexibly respond to market conditions across a wide range of asset classes and sectors. Their value also continues to rise in the securities lending markets as both lenders and borrowers reap the mutual benefits of the current market dynamics. Over the past two months, exchange-traded funds have been one of the standout asset classes in the securities lending market, delivering strong year-over-year revenue growth. As uncertainty rises across both the political and financial spectrum, interest in ETFs in the securities lending market is expected to grow further.

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Editor’s note: The abstracts for this article were chosen by the editors of Seeking Alpha.