NVDL: Pain Waits (NASDAQ:NVDL) | I’m looking for Alpha

Before we get too far into this, leveraged ETFs are generally very risky financial products. I’ve covered some of them previously for Seeking Alpha here , here , and here . The way these types of funds usually the work is that it rebalances daily to optimize returns. This works quite well when shareholders enter in time at the start of a rally in the underlying stock or index. Such was indeed the case with GraniteShares 2x Long NVDA Daily ETF (NASDAQ:NVDL). In this article, we’ll look at the details of the fund, NVDL’s impressive performance since the fund’s inception, and make my case for why I think the party is probably over.

Background details

As you may have already guessed from the fund’s name, NVDL exists only to produce twice the daily returns of Nvidia Corporation (NVDA) stock. For example, on a day when NVDA stock rises 5%, NVDL should rise about 10%. The same goes for the descent. If NVDA falls by 5%, NVDL should fall by 10%. Because the fund is rebalanced daily to optimize for double returns, NVDL’s price should theoretically decline over time if NVDA experiences a sustained period of decline or decline. Thus, NVDL should really only be held when NVDA is in a strong uptrend and for short periods of time in a tactical strategy.

Notably, NVDL isn’t the only product on the market that aims to produce twice the returns of NVDA stock. Other funds that offer the same strategy include Direxion Daily NVDA Bull 2x Shares (NVDU) and T-Rex 2x Long NVIDIA Daily Target ETF (NVDX):

Click to enlarge

Source: Seeking Alpha.

Because of the 1.15% expense ratio, NVDL is a bit more expensive for full-year holders (I don’t recommend holding leveraged ETFs that much). Although, when we’re talking about a fund that doubles NVDA’s daily return, I suspect a few bps probably doesn’t matter that much to shareholders. Perhaps what matters more is the track record. The GraniteShares fund is by far the largest, with $5 billion in assets under management (“AUM”), and was launched before each of the other two funds.

Performance

Comparing each fund year-to-date probably gives the most accurate picture, as neither NVDU nor NVDX existed a year ago:

Here we look at three funds that have produced great returns to date, although the total returns are actually quite different. NVDL is right in the middle at 207% year-to-date, while NVDU is well below that at 167% and NVDX leads the way at 237%. Compared to NVDA, only NVDX has met a true 2x target since the start of 2024, although NVDL is relatively close. Again, NVDL has been around longer than the other two funds, so looking at the overall performance of the fund can be useful:

Since the fund’s inception near the end of 2022, the total return for Day 1 shareholders has been over 1,100%. This is against NVDA’s total return of 500% over the same time period. Thus, NVDL actually more than doubled the fund’s daily target more than twice 20 months. In my experience, both in terms of hedging and using these types of funds for trading, this is not a typical story and speaks to the intensity of NVDA’s run over the past two years. It was incredibly impressive, to say the least. However, I think this has generally been an anomaly in the world of double-leverage ETFs and will likely end.

The case against NVDA

I’ll skip ahead to the reveal at the bottom of the page to be as transparent as possible. I have a synthetic short position on NVDA via a long position in the Tradr 1.25X Short NVDA Daily ETF (NVDS). If NVDA goes down, I will make money. We have taken this position for several reasons which include but are not limited to the following;

1. Sentimental signals
2. Technical analysis
3. Company evaluation.

1: Signals

We’ll start with sentiment signals first. Regarding small sample sizes and anecdotal evidence as justification for a broader view, I see too much exuberance from the NVDA bulls. We could start with the well-documented moment earlier this summer when Nvidia CEO Jensen Huang autographed a pair of women’s underwear at a tech conference. This is the kind of thing usually seen by celebrities in the entertainment industry rather than CEOs of tech companies. More recently, the company’s latest earnings report had an unofficial watch party at a bar in New York. Which is again a very unusual activity for Wall Street attendees and more like something sports fans would do during a major game or event.

Perhaps these signals could simply be seen more as symptoms of high interest from retail investors. In the chart below, I show the retailer’s active percentage with vertical orange lines indicating the earnings ratios. It is very common to see spikes in retail trader activity right after earnings. However, the last two quarters have seen sustained growth in retail engagement.

In the second half of 2023, the percentage of retail activity was rarely above 6% in most sessions. Since the beginning of March, the percentage of retailers has been below 6% in just 4 sessions. In fact, the percentage of activity by retailers has not been below 10% since the end of July. The point should be clear here; retail trade is in this trade to a great extent. In my view, this is a signal that we are close to the top of the cycle if we haven’t already.

Technical analysis

I make no claim to be an expert technical analyst by any stretch of the imagination. When using TA I try to keep it simple and use things like moving averages over long periods of time. I see several potential warning signs with this daily NVDA chart:

First, NVDA has not seen its 200-day simple moving average in over a year and a half. My base case is that we see NVDA testing that level in the coming weeks. This MA is shown by the green line in the chart above and is 17% below current levels at the time of posting. This would involve a 34% drop in NVDL if the stock actually retraces that moving average.

It may coincide with a possible test of the 200-day MA would be the early August low of $90 per share. It’s certainly within the realm of possibility that the stock could look to that level for support. But there are additional problems. For example, we now have two lower highs from pullbacks going back to mid-June, indicating a more significant top pattern. And there is an enormous void that has yet to be filled as of May 2023. There is no rule that says all voids must be filled. But given how overvalued this stock is, I don’t think it can be completely ruled out.

Company evaluation

Nvidia is currently trading at 21 times forward sales. That’s a 650% premium to the IT sector median. In fairness, these P/S ratios are a testament to how stellar the company’s gross margin has been in the race to scale AI computing. But even going by P/E multiples, NVDA cannot reasonably be called “cheap.”

At 38 times forward earnings, NVDA trades at a 40% premium to the IT sector median and is the second-most overvalued company in the Magnificent Seven based on that value, behind only Tesla (TSLA).

Other considerations

There are also additional concerns with NVDA. Recently, we’ve seen insiders sell stocks at an accelerated pace. Since mid-June, Jensen Huang has sold 4.8 million NVDA shares for $580 million. To be clear, Huang is still a major shareholder in the company and these sales represent a minimal portion of his total holding. To date, insiders have sold $1.5 billion in company stock, with the majority of these sales occurring in the past 3 months. We also learned of a subpoena as the United States DOJ is looking into possible antitrust violations by the company.

Please review the risks of leveraged ETFs as explained in the linked SEC bulletin before placing any trades in the NVDL. These risks include extreme volatility, declining timing and volatility, and the real possibility of losing your entire investment. Normal risks can be exaggerated with single-act ETFs like NVDL. Only experienced traders who fully understand the risks should trade them. This article further explains the important risks of such ETFs with examples.

Closing thoughts

NVDA has experienced truly astounding growth over the past two years. Given this growth, it’s probably no surprise that retail has found its way into stock to such a large extent. But there’s a pretty obvious warning sign there. Readers are no doubt familiar with the concept of rallies faltering when taxi drivers start giving stock tips. Perhaps in this era, that sell signal comes from the Uber ( UBER ) driver. Or maybe earnings ratio watch parties work just as well. Beyond sentiment, I see red flags on the chart. I see red flags from inside sales. I see a red flag from the DOJ. And I see a red flag from a double-leveraged ETF that hasn’t yet punished people for owning 2022 stocks.

Things that have a beginning have an end. I’m certainly not saying to short NVDA or even sell NVDA for that. But I suspect the company’s growth has been priced in for now, and NVDL is unlikely to continue this meteoric rise. NVDL is a sale.