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Summary Direxion launched two leveraged cybersecurity ETFs this past week. These ETFs may be debuting at a time when the popularity of cybsecurity stocks has already cooled and valuations are still very high. History has taught us the dangers of investors choosing to chase past performance or chasing “hot” stocks. It was probably just a matter of time before Direxion – one of the primary issuer of leveraged and inverse ETFs – jumped on the popularity of cybersecurity stocks. This past week, Direxion launched the Direxion Daily Cyber Security Bull 2X Shares ETF (NYSEARCA: HAKK ) and the Direxion Daily Cyber Security Bear 2x Shares ETF (NYSEARCA: HAKD ) options on the cybersecurity sector. But like many products that get launched after the initial popularity soars, the timing often proves to be a dangerous investor trap. The first ETF to jump on the trend – the PureFunds ISE Cybersecurity ETF (NYSEARCA: HACK ) – has quickly racked up well over $1B in assets and was up over 30% within 8 months of its debut. Cybersecurity stocks have cooled off though thanks to the global economic environment and now the fund is up just marginally since it opened. HACK data by YCharts Followers of behavioral finance will tell you all about investors’ tendency to chase past returns and how it often results in buying high and selling low. You probably won’t be surprised to learn that AUM began ramping up at their fastest pace as cybersecurity stocks were peaking earlier this summer. Just in time for these investors to experience the subsequent pullback. Which is why launching a leveraged cybersecurity ETF right now is dangerous. Investors are still being told in the mainstream media that cybersecurity companies are “hot” and money is still pouring into these products. Even after the recent pullback, many of these cybersecurity companies are trading at very rich multiples. Many of these companies still have yet to turn a profit so measuring them by P/E would be unfair. Instead, let’s use the P/S ratio to try to gauge valuation levels. The S&P 500 as a whole currently trades at a P/S multiple of 1.63. Popular stocks in the sector include Palo Alto Networks (NYSE: PANW ) at 16.98, FireEye (NASDAQ: FEYE ) at 11.13, Fortinet (NASDAQ: FTNT ) at 8.97 and Checkpoint (NASDAQ: CHKP ) at 9.33. While the P/S ratio isn’t necessarily an all-in-one measure, it does go to say that even after the recent pullback cybersecurity companies are still very expensive and could indeed fall much further. Looking back at the Nasdaq bubble in 2000 gives us many examples of investments launched at the wrong time. Take the Jacob Internet Fund (MUTF: JAMFX ). This fund was one of the first mutual funds targeting primarily internet stocks at the time. In the six month period from roughly October 1999 through March 2000, the Nasdaq Composite rose over 175%. The Jacob Internet Fund debuted in December 1999 right as tech stocks were about to hit their peak. What happened next is still a good lesson in the dangers of chasing performance or “hot” stocks. The Jacob Internet rose around 20% in the few months after its debut but by the second half of 2001 the fund had lost around 95% of its 2000 peak value. JAMFX data by YCharts That’s not to suggest that a crash like that is imminent in cybersecurity companies but it does make very clear that jumping into a cybersecurity ETF – especially a leveraged cybersecurity ETF like the two launched last week that are designed to magnify the returns of the sector – could be especially dangerous. Conclusion Direxion is well within their boundaries launching these two ETFs right now but it might not be doing the average investor any favors. These ETFs have a triple whammy of risks – investing in risky cybersecurity stocks, investing in leveraged securities and investing when much of the frothy returns may have already been had. These ETFs are very much a case of “buyer beware” for investors. Disclosure: I am/we are long FEYE. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Scalper1 News
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