XSW - IGV: Vigilance Required As Technology Speculation Worsens And Rallies Continue

2023-06-27 10:09:21 ET

Summary

• The innovative technology space may face headwinds due to ongoing recession fears and a potential "baby bubble" in certain speculative areas.
• IGV has outperformed peers as well as the broader market in recent times, but its top holdings still show concerning valuations and signs of an imminent correction.
• I rate IGV a Hold, as tech stock prices remain high, but the rally could lose momentum due to the Federal Reserve's hawkish stance.

Technology has marched along well in 2023 after a rough 2022, but I believe the technology bulls only have so much steam left. Ongoing recession fears are causing investors to pull back from what could be considered a "baby bubble", which has manifested recently in innovative technology names like Palantir (PLTR) and C3.ai (AI). Though these companies are not part of the iShares Expanded Tech-Software Sector ETF (IGV), I believe their recent declines signal a grim forecast for innovative technology as a whole. IGV and similar ETFs could catch some serious headwinds sooner rather than later. As more investors begin to fully grasp the propensity for rate hikes to hurt tech securities, I believe selling pressure in this space will invigorate. However, the environment is still somewhat uncertain and selling may not yet be the most rational call. I rate IGV a Hold.

Strategy

IGV tracks the S&P North American Expd Tech Swre TR USD Index and uses a representative sampling technique. Individual holdings are weighted by market capitalization, which must be at least $500mm for all stocks within the index. The same securities must also have an average daily trading volume of no less than 50,000 shares. Additionally, IGV has a dividend reinvestment plan ((DRIP)), which allows investors to automatically reinvest their dividends in new shares of this ETF.

IGV's investment strategy mainly plays on the idea that technology is key in driving long-term economic growth. As a result, this fund dabbles in companies primarily associated with software, interactive media, and interactive home entertainment.

Holdings analysis

This ETF invests almost solely in the technology sector, with only minuscule appearances from communications, industrials, and financials. These stocks are also located exclusively in the United States and trade in U.S. public equity markets.

The top 10 holdings in this ETF account for almost 60% of the entire fund, which consists of over 120 securities. The top three holdings alone comprise almost a third of IGV. Therefore, this ETF's numerous holdings don't necessarily indicate quality diversification.

ETF performance analysis

IGV vs. the rest of technology: On pace

This year has been one for innovative technologies such as artificial intelligence ((AI)) and cloud computing, which similarly require software services. IGV has been moving similarly to funds focused on said technologies and has outperformed the market in 2023.

IGV vs. Peers: Plenty of Advantages

IGV has consistently outperformed certain peers thus far, which include but are not limited to the SPDR S&P Software & Services ETF ( XSW ) and the Invesco Dynamic Software ETF (PSJ).

I attribute this performance to IGV's slightly broader focus as well as its weighting strategy. IGV has a decently-strong focus on both software as well as interactive media and entertainment. Alternatively, XSW is more focused on software services while PSJ is more focused on the dynamic software industry. Investors in IGV may therefore gain access to more potentially-rewarding spaces that are well-positioned to benefit from software evolution. Additionally, though equal weighting may prompt more stable performance, I believe it also might ultimately hinder momentum. Therefore, I think IGV is a better long-term pick for those willing to endure greater price fluctuations.

Sounding the valuation alarm in IGV's top holdings

Oracle

Oracle Corporation ( ORCL ) has a TTM Non-GAAP P/E Ratio slightly above the sector median. This does not necessarily indicate irrational overvaluation and has actually before indicated that investors are just expecting increased earnings. However, I don't believe that to be the case as of now. I believe that ORCL is somewhat overvalued after recent rallies which might be slowing.

ORCL also had a steady uptrend before a recent explosion, as seen below.

ORCL's recent price trend is also displaying red candlesticks of size and frequency not before seen in the time this stock has traded above the 50-day moving average. This could indicate an imminent correction, which could hurt IGV's performance.

Adobe

Adobe Inc. (ADBE) has consistently traded above 30x earnings in recent times, which I also attribute to speculation in the technology sector.

ADBE has increased concerningly fast in recent periods but has recently displayed red candlesticks which appear similar to the ones that last pushed this stock below the 50-day moving average in early May. That being said, I believe this stock may have trouble staying afloat in the coming periods.

Microsoft

Microsoft (MSFT) remains a tech juggernaut and a key player in the market, so I'm slightly less concerned with this stock's movement. However, I don't believe MSFT is immune to the effects of speculation and is quite overvalued as a result. As seen below, MSFT's TTM Non-GAAP P/E Ratio is roughly double that of the sector median.

Overall, MSFT's price trend is significantly more stable and less concerning than that of ORCL and ADBE.

Technology might soon be on the chopping block

During the bear market initiation in 2022, many tech stocks were the first to go. I'm beginning to see some slippage in the same companies as interest rate hikes pop up in the forecast for the rest of the year. The chart below depicts just how fast IGV sank below the S&P at the beginning of last year.

Conclusion

As the Federal Reserve forwards its hawkish stance, the technology rally could lose significant momentum in the coming terms. However, tech stock prices are still quite high and many still see an upside. I don't think investors should necessarily be quick to sell, but buying prices and underlying valuations in IGV are also quite concerning. Therefore, I rate this ETF a Hold.

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