IXP - iShares Global Communications ETF: In Vogue

Summary

• Recent intermarket movements provide support for risk-on themes like communication services.
• Most of these stocks have already come through drastic earnings revisions and headcount-related adjustments may reflect favorably.
• Forward valuations remain cheap.

Investor psychology seems to be a major force pushing equity indices ever higher and we seem to be living in a market melt-up. - DeFred Folts

Why IXP?

Market participants who pay attention to the developments on the timeline of The Lead-Lag Report would note that I’ve been highlighting the prevalence of supportive inter-market conditions for risk-taking.

Low vol is being trumped by high beta even as the VIX has dropped to the sub-20 levels, small-caps are shining ahead of large-caps, Bitcoin has been on fire in 2023, high yield credit spreads appear to be petering out, utilities have gone off the boil, and even Lumber is trying to get its mojo back. In fact, the only reason my proprietary Lumber/Gold signal hasn’t yet joined the Utilities and Treasuries signal is because of Gold is still trying to make the most out of the dollar’s weakness.

Crucially, don't get too fixated on price action alone. As noted in a tweet in The Lead-Lag Report, the breadth in the tech-heavy Nasdaq has been quite exemplary. Around 7 months back, the percentage of Nasdaq stocks trading above the psychologically crucial 200-day MA barrier was just in single-digit terms; these days, it is well over 40%!

Nonetheless, if you're on the lookout for suitable risk-on themes from the markets, you may consider looking at a beaten-down sector that has recently started making waves. I'm referring to the communication services sector, and one way to play this is to opt for the iShares Global Communication Services ETF ( IXP ).

IXP gives you exposure to 75 global stocks that are exposed to arenas such as traditional media, social media, entertainment, gaming, telecommunications, and search engines. Even though this is supposed to be a global portfolio on paper, note that close to two-thirds of the holdings come from the US alone.

Over the past year, IXP has underperformed both the Nasdaq and the S&P500 and could attempt to make up lost ground.

Besides, as noted in the ‘Leaders-Laggards’ section of my subscription services, a ratio measuring the strength of communication services stocks’ to the S&P500, recently surged past its 20DMA for the first time since Sep 2021!

If the growth side of the market can show the smallest sign of leadership, you would expect something like IXP to be of the key participants in this shift, so long as the Fed doesn’t play spoilsport by latching on to that old hawkish narrative again.

Despite the recent relative strength, I can appreciate that some market participants may have been left scarred by the adverse performance of this sector since the second half of 2021 and would be wary about getting in. Admittedly, IXP's top holdings - Google ( GOOGL , GOOG ) and Meta (META) won't quite enjoy the same clout they previously enjoyed in the digital ad market with uncertain corporate budgets and Apple's (AAPL) ATT restrictions. A range of industry reports also suggests that Tik Tok has been making quick inroads into the market so much so that Google and Meta will see their market share drop to 45% by the end of 2023, the lowest in 9 years.

A recent speaker on the Lead-Lag Live Twitter Spaces has also urged investors to pay greater attention to profit contraction.

I can understand his concerns, but one also does wonder if a lot of the risks are baked in. For instance, the image below gives you a sense of the level of forward earnings revisions that have taken place with IXP's top 10 holdings (~65% of the total portfolio) over the last 3 months. The percentage figure tells you the number of downward EPS revisions that have taken place as a proportion of total revisions, with the exception of Netflix (NFLX) (~21%), AT&T (T) (~47%), and T-Mobile (TMUS) (~38%), note that the bulk of revisions has been overwhelmingly negative.

There’s an outside chance some of these EPS revisions could see a pivot in the other direction once the street begins to get a sense of the steep level of workforce adjustments that these communication services stocks have been making; this may reflect favorably on the cost base and the drop through to the bottom line.

Even without those adjustments coming into play as yet, do consider that IXP offers you tremendous weighted average earnings growth potential of 30% , around 700bps higher than what the constituents of the S&P500 look set to deliver.

Meanwhile note that despite some strength in recent weeks, the forward valuation of IXP's top 10 holdings (~65% weight) are still very cheap with the forward P/E discount for the top 9 names ranging from 12% to 57%. T-Mobile is the only name that trades at a steep premium.

Risks

While near-term conditions for IXP look good, investors shouldn't proceed brazenly without sufficient risk management. In fact Samantha LaDuc, a guest on The Lead-Lag Live Twitter Spaces recently explored the contours of the tech rally, and both of us felt that a credit event later on in the year may result in this recent rally proving to be a false break out.

For further details see: