IVE - IVE: Rolling Sell-Off From Cloud

2023-10-29 02:01:54 ET

Summary

• IVE has exposure to tech, financials, and industrials, with less exposure to mid-cap tech and healthcare.
• Valuations in tech are a concern, as shown by negative reactions to earnings, while financials face risks from deposit beta and economic downturn.
• Cloud stocks have experienced sell-offs, impacting IVE and the overall market, highlighting stretched valuations and the potential disillusionment with AI.
• Overall, equity valuations depend on continued good news. Yet to leave the current market limbo, we need bad news. IVE and general US equity indices are not the right place to be now.

The iShares S&P 500 Value ETF ( IVE ) is pretty exposed to the typical index drivers in the US. A lot of Microsoft ( MSFT ) and some of the cloud majors like Amazon ( AMZN ). Ultimately, there are some differences between the IVE and the general market, which is that mid-cap tech doesn't feature highly, and besides the mega caps in tech, the plurality of the exposures are in financials and also a fair bit of industrial exposure. We think that there are issues with the valuation in tech, shown by the negative reactions to pretty healthy earnings. On financials, deposit beta is kicking in, and some of the consumer and fee-earning elements of the business are somewhat at risk as the economy looks at a downturn.

Breakdown

Here are the sectoral exposures:

Compared to the broader index , there is 10% less IT exposure, 6% more financial exposures, and also less healthcare exposure by about 5%. Besides that, the exposures are pretty similar in terms of allocation size.

PEs are consequently lower, but not by much, a 19x PE or so versus the 21.3x for the broader ( IVV ) index. Expense ratios are a little higher at 0.18% rather than 0.03% for the IVV.

There are two issues we have with the ETF. The first is the prevailing valuation, especially in light of recent news. The second is the concerns we have in general about direction in some of the exposures.

Bottom Line

There's been a bit of a rolling sell off among some of the cloud exposed stocks beginning with Alphabet ( GOOG ) over otherwise healthy results in cloud, but not up to growth expectations. This caused speculative sell-offs in other cloud majors that hadn't even reported earnings due to expectations of similar issues including Microsoft and Amazon. Amazon managed to reassure investors with yesterday's report, but since these others are highly represented in IVE, it took a hit, and so did the whole market. The fact that all it took was growth to be below expectations shows that valuations are getting stretched, and brisk growth is necessary to justify them as the reality of a 4-5% risk-free return over longer periods through Treasuries takes hold.

Then there is the ongoing issue that the hype around AI will surely wane . Besides the economics of AI not necessarily being that fantastic, with them being difficult and expensive to develop while also deteriorating inexplicably in performance, on top of the potential regulatory issues incoming, disillusionment is incoming and there's a ways to fall in terms of sentiment .

In financials, the other substantial exposure in the IVE, there is scope for declines in fee-based income due to economic pressures. There was hope for greenshoots in M&A but optimism has been tempered down . While some IPOs have come tentatively to market, they haven't performed that well after listing, thinking specifically of Arm ( ARM ) which did not open the IPO floodgates at all, showing that appetite even for technology stocks at peak AI hype was still pretty limited. In general, sponsors have also been very slow to return to the market as their economics have been impaired by higher rates. Restructuring hasn't really picked up yet either, CFOs are still handling liquidity issues. Then, to the extent that full-service financial companies are exposed to consumer finance, there is risk on that side from higher benchmark rates. Even brokerage incomes haven't been that good on fixed income, as investors stay on the sidelines for fixed income markets until duration bets can be more effectively valued. Equity is a bit better, but the shrinking overall volatility these last quarters have started decelerating those segments.

On NIMs, there is also the issue of deposit beta. In the US especially there is a lot of competition from alt-finance as well to take deposits and offer competitive returns to savings accounts. Even most brokerages now offer yield on cash balances. NIMs don't have much more upside .

The ultimate problem is that which was mentioned before, which is expectations are just too high. While there is underlying growth in the economy, with GDP continuing to rise even in real terms , the continuing inflation is evidence that the effects of interest rates have not taken firm effect. Considering that rates are being mitigated by lots of fixed corporate debt which will rollover in the maturity walls of 2024 and 2025, the full transmission of the rate policy on corporates starts around then. Until inflation is firmly brought down by a decent recessionary force, we cannot be bullish on equities in a basket valued at almost 20x PE, implying a 5% earnings yield against more than that on short term Treasuries with no risk. Future rate hikes are on the table , and disappointment could come both on the demand side as well as on continuing cost of capital expectation revisions.

For further details see: