Investment Thesis
Despite a 28.71% share growth over the last year, ProShares UltraPro S&P500 ETF (NYSEARCA:UPRO) is currently on a bearish trend, losing 17.92% over the last month. I believe this bear trend has been accelerated by the market correction that occurred last month, which affected the broader S&P500 index and its leveraged ETFs.
While September Is Historically the Worst Month for the S&P 500, with a strong rebound in the following months, I am inclined to believe this year, the potential of a solid recovery is minimal given the bleak market outlook.
According to technical analysis, UPRO is on a bearish trend that appears to be weakening and reaching a support level where a reversal is likely. While historical evidence shows that October marks the start of the S&P500’s recovery after a dismal September performance, the bleak market outlook tests this trend. Based on this criterion, I propose patience as we wait to see how the trend acts, particularly when it reaches the support zone. If the company can withstand the market’s headwinds, I anticipate a reversal near the support line, which might signal a decent entry position.
Tough September
Following a poor performance marked by UPRO’s 19.92% share decline last month, I believe this could be a result of two major reasons. First is the market correction in September 2023, which affected the broader S&P 500 index and its leveraged ETFs. UPRO seeks to provide daily investment results that correspond to three times (3x) the daily performance of the S&P 500 index, which means that it magnifies both the gains and losses of the underlying benchmark. Therefore, when the S&P 500 index falls, UPRO falls even more.
The S&P 500 index declined by 4.8% in September 2023, which, from my observation, was its worst monthly performance since March 2020. This was primarily due to factors like reservations over the stalling economic recovery, rising inflation, the reduction of the Federal Reserve’s stimulus, and the debt ceiling and government spending uncertainty. As a result, UPRO declined by 14.5% in September 2023, which was more than three times the decline of the S&P 500 index.
Another reason UPRO is trending down could be the outflow of funds from the ETF, which indicates lower demand and a bearish sentiment among investors. UPRO experienced a net outflow of about $89.4 million in the week ending September 17, 2023, which was a 4.4% decrease in its shares outstanding. This was one of the largest outflows among the leveraged ETFs that week, which may have contributed to the downward pressure on UPRO’s share price.
Looking at these aspects, I believe that they have pointed out a strong downward pressure, which historically has been correcting in October; however, given the bleak market outlook, UPRO resilience will be tested. From where I stand, I expect the trend to continue in the short run until at least in the support zone around the $38.81price where a rebound is likely or a breakout following the downward pressure to a new support trend perhaps, at about $31.32 which is the next strong support zone below the current zone.
Market Headwinds: A Bleak Outlook
The leveraged ETF market faces several headwinds, which, in my view, translate to a bleak outlook. In this section, I will cover two major headwinds. To begin with, is the high inflation and interest rates. The global economy has been characterized by historically high inflation and interest rates since 2022.
Even with this high interest rate, they are projected to stay elevated until 2024. The Fed Open Market Committee members’ median forecast puts the Fed funds rate at 5 to 5.25% by the end of 2024, barely a quarter-point lower than it is now.
In my view, the rising inflation and interest rates may erode the returns and increase the costs of the leveraged ETFs. The inflation may reduce the purchasing power and value of the ETFs’ assets and liabilities, while the interest rates may affect the ETFs’ borrowing costs and net investment. All these will, in my view, translate to a further downside potential for ETFs.
Another headwind is the Federal Reserve Focuses Monetary Policy on Fighting Inflation of the Federal Reserve’s stimulus, which may reduce the liquidity and support for the leveraged ETFs. This year, the Fed remained committed to reversing its prior quantitative easing (QE) program, which included purchases of Treasury and mortgage-backed securities. QE was designed to increase liquidity in capital markets. The Fed is reducing its balance sheet of these assets, which peaked at around $9 trillion. This so-called “quantitative tightening” strategy, paired with higher interest rates, is intended to contain inflation by reducing economic development through increasing borrowing costs. The Fed’s balance sheet has shrunk to around $8.1 trillion since early 2022, down 9.6% from its peak in April 2022 but still significant by historical standards.
The stimulus may have helped the performance of the major indexes and their leveraged ETFs in 2023, but as the Fed ceases bond purchases and increases policy rates, the leveraged ETFs are likely to encounter additional headwinds and problems. In my view, this translates to a bleak outlook for ETFs until the Fed reverses these corrective measures. In conclusion, ETFs are currently facing serious headwinds that will exert pressure on the market, translating to a potential bearish trend until the Fed reverses its measures.
Technical Analysis
Utilizing technical indicators, such as oscillators, trend lines, and moving averages, is one approach to examine UPRO from a technical standpoint. These indicators help identify the direction and strength of the price trend, as well as the potential support and resistance levels. My UPRO’s technical analysis is as follows:
Moving averages: UPRO is currently trading below its 50-, 100-, and 200-day moving averages, indicating that it is in a downtrend with negative momentum. Additionally, the 50-day MA is above the 100-day and 200-day MA; this implies that the recent signs of a bullish trend are not a reliable buy signal but a false breakout. However, the gap between the moving averages is closing, implying that the downtrend is losing pace and a reversal is probable.
Trend lines: UPRO has been trading within a descending channel since Nov. 2021, which indicates that it is in a bearish trend and has a negative slope. The upper trend line acts as a resistance level, while the lower trend line acts as a support level. In October, UPRO bounced off the support level, but its bullish trend has been halted by the tough September performance and rendered this trend a false breakout, as indicated by the 50-day MA being above the 100-day and 200-day MAs. I believe a reliable buy signal is a retest on the support level. If it proves resilient to the headwinds and bounces off again, the middle line can be a good entry point; otherwise, the headwinds could force it to the next support level at about $12.5 per share.
Oscillators: The relative strength indicator [RSI] for UPRO is currently 47.3, indicating that it is neither overbought nor oversold. The RSI, on the other hand, has been exhibiting a positive divergence with the price, which implies that the RSI is making higher lows while the price is making lower lows. This signals that the bearish momentum is fading and that a reversal is possible.
Risks
Like any other investment, investing in leveraged ETFs has its share of risks, which explains why FINRA warns retail investors about investing in them. The major risk associated with leveraged ETFs is the risk of value erosion. With this in mind, some risks of value erosion associated with UPRO with a specific focus on the impact of leverage are:
Increased costs and fees: Leverage can increase the costs and fees of UPRO, which can reduce its returns and value. It uses financial derivatives and debt to achieve its leverage, which may incur higher interest expenses, margin requirements, and transaction costs. UPRO also has a relatively high expense ratio of 0.90%, which may erode its returns over time.
Increase Volatility: Leverage has the potential to magnify both UPRO’s gains and losses, increasing the fund’s volatility and drawdowns. It can further magnify UPRO’s tracking flaws and compounding effects, causing the fund to diverge from its target return and performance over time.
Therefore, investors interested in UPRO should be aware of the potential rewards and risks of leverage and monitor their holdings as frequently as daily.
Investment Take
Following a solid last year’s performance characterized by share growth of 28.71%, UPRO faced a rough September characterized by a share price slump of 17.92%. Historically, September has been a tough year for S&P500 and ETFs, followed by a strong comeback from the month of October. While this could be possible, investors should be wary of the headwinds that could limit a recovery from September’s dismal performance.
From a technical analysis perspective, the weakening bearish trend could be a sign of a strong comeback on the horizon. Should UPRO prove to be resilient to the headwinds, a good entry point could be at about $28.4 support zone, which will be reaffirmed by a retest following the first bounce-off in October 2022. In the event the price breaks this zone, I think it will signify it has been adversely hit by the headwinds forcing it down. If this is the case, the next strong support level could be in the region of $12.5. Given this background, I recommend patience as we await a retest on the support level at $28.4.
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