QQXT - QQXT ETF: Well Positioned As Generative AI Diffuses Throughout The Economy

2023-06-29 11:21:59 ET

Summary

• The First Trust NASDAQ-100 Ex-Technology Sector Index Fund (QQXT) is a good investment option as it provides exposure to non-tech sectors that are also benefiting from AI advancements.
• The diffusion of AI across the economy is expected to accelerate, benefiting non-tech sectors. Companies across various industries are modernizing their business processes and workflows using AI, expanding the market size. According to McKinsey, Gen AI could deliver $13 trillion yearly in economic benefits across industries.
• Despite concerns about rising interest rates and a potential economic slowdown, the author maintains a bullish stance on QQXT. The ETF is undervalued with a P/E multiple of 18.62x and offers a higher yield and dividend growth over the last three years. The author sets a modest target price of $85.84 for the ETF by the end of the year.
• It is also more equal-weighted and less concentrated, thereby reducing volatility risks.

The First Trust NASDAQ-100 Ex-Technology Sector Index Fund ( QQXT ) excludes the big names associated with Generative AI. As such, it has underperformed the tech-heavy Invesco QQQ ETF ( QQQ ) by more than 15% as illustrated by the blue chart below, with the gap widening since May after Nvidia's ( NVDA ) sales outlook for its intelligent GPU chips beat analysts' expectations by more than 50% .

However, the longer-term price action shows that QQQ has not consistently outperformed QQXT which means that there is the possibility of their path crossing again, which augurs well for the non-tech ETF.

Thus, my objective with this thesis is to show that an investment in QQXT makes sense at this stage and to make my point I will emphasize some of ChatGPT's attributes and also show how related technologies like ML (machine learning) tend to get diffused across the wider economic ecosystem instead of being restricted to the tech world.

At the same time, I highlight the First Trust ETF's differentiated equal-weighted approach relative to its Invesco peer in view of concentration risks.

Generative AI and QQXT's Equal-Weighted Approach

First, the GPU chips developed by Nvidia ( NVDA ) are being used by big service providers like Microsoft ( MSFT ) and others to expand their public cloud so that they can support the rising demand for ChatGPT-style chatbot applications across all industry sectors.

Looking deeper, ChatGPT was initially developed by OpenAI, and with the launch of the latest version in the form of GPT-4, millions are accessing it throughout the world, enthralled by its ability to generate intelligent reports on the fly. Adoption is being facilitated by the underlying technology or Generative AI using natural languages which are understandable to every one of us. There is also its capacity to provide answers like humans when being queried through the chatbot.

In contrast, ML, which has been around for years implies the need to be trained in complex computer codes and is about learning how to interpret data, in turn leading to the development of Recommendation AI. This was initially used by advertisers to identify those most likely to opt for a purchase and to propose the corresponding product before being adopted by social media companies like Meta Platforms ( META ) to promote user engagement in order to "hook" people to their platforms.

Others like giant online retailer Amazon ( AMZN ), whose shares are held by QQXT, have applied analytics tools to their marketplaces to make shopping easier for clients while also using intelligent robotics to streamline operations in their warehouses.

Looking closer at the above holdings, one can notice that, unlike QQQ which dedicated 6.91% to Amazon as of June 26, it is only 1.64% for QQXT. Thus, this ETF is more equal-weighted with its 63 holdings (excluding cash) in addition to covering non-tech stocks.

Looking further into the difference, QQQ holds more stocks or 101 (excluding cash), but the fund is highly concentrated as its first ten holdings make up 58.88% of its overall weight. This compares to only 16.59% for QQXT and also accounts for its lower concentration risks.

Consequently, if you have missed the rally on Nvidia and the momentum imparted to other big tech names by Generative AI, which has equally propelled QQQ by 36.63% in 2023 alone, it is time to think differently. One option is to stop being focused only on the narrow tech theme and think more laterally to take advantage of the technological developments diffusing across different industries.

AI Diffusing Across the Economy, Benefiting Non-Tech

This Diffusion throughout the economy is motivated by Generative AI's ability to bypass certain manual tasks. Now, the higher the degree of automation less is the need for costly man-hours of work while allowing for better work output which signifies that this innovation brings better labor productivity, which can range from 0.2% to 3.3% according to research by McKinsey when deployed with other technologies. As a result, there is a growing demand to improve corporate processes (workflows) in various industries.

Talking more concrete figures, the innovative technology could deliver $2.6 trillion to $4.4 trillion yearly in economic benefits across industries with life sciences (which forms part of QQXT's healthcare sector as pictured above) among the biggest beneficiaries. Furthermore, if you consider that the world's GDP in 2022 was estimated to be $100.2 trillion , then, as per my calculation, around 3.5% (3.5/100.2) AI-led growth is possible based on the midpoint of $2.6 trillion and $4.4 trillion, or $3.5 trillion.

Now, considering that the infrastructure to support such applications has been built since the beginning of this year, as Nvidia's chips get fitted into Microsoft's Azure for example, most of the benefits are likely to be seen from mid-2023 onwards. Thus, based on the current share price of $82.94 appreciating by 3.5%, I have a target of $85.84 for QQXT by the end of this year. This is a moderate target and takes into consideration that the ETF has already gained 8.66% YTD.

Interestingly, McKinsey further adds that Generative AI will pull along other AI flavors like Conversational, and Recommendation mentioned earlier. Additionally, most of the initial productivity improvements should be made in developed markets including the U.S., or the country where QQXT's equities are domiciled.

Fewer Volatility Risks

Shifting to a cautionary posture, this bullish position may sound counterintuitive as it comes at a time when interest rates remain sky-high amid concerns of a mild recession striking the U.S. economy by the end of this year. However, I remind investors that the U.S. Consumer Confidence figure of 109.7 for the month of June represented an increase over May's 102.5. On top, this was the highest rate of improvement since January 2022, somewhat contrasting with talks about the economy slowing down. One of the reasons for this could be inflation being on a net downtrend since June last year, probably due to the Fed's juggling with interest rates seeing some success.

Another reason for preferring non-tech is that those who have sought refuge in the big tech stocks during the March banking turmoil should brace for volatility as the U.S. strengthens its supply chains under the CHIPS Act. For this matter, there was a lot of uncertainty about Nvidia's sales prospects as a result of the U.S. Department of Commerce erecting export restrictions in October 2022. This time around, episodic volatility could surge as geopolitical tensions escalate between the U.S. and China, especially, after Chinese regulators banned Micron's ( MU ) chips on security grounds. Thus, America may strike back to restrict the exports of its most intelligent microchips to China.

Moreover, as pictured above, QQXT is a much smaller fund whose Assets Under Management only makeup for around one-thousandth of its giant peer, which signifies that it is less liquid. Furthermore, it has delivered much lower capital gains.

On the other hand, with fewer assets concentrated in the top holdings and being more equally weighted, Morningstar rewards it with a " Low " risk profile. It is also undervalued with a Price-to-Earnings multiple of 18.62x, compared to 26.25x for QQQ. Another advantage of the First Trust ETF is that despite its higher fees of 0.6%, it pays higher yields and its dividend growth has exceeded its peer by far, as tabled above.

Going Forward, Non-Tech To Benefit More

In conclusion, this thesis has shown that it is QQXT is the appropriate choice as that Generative AI, as well as other flavors of artificial intelligence, get diffused across the value chain. In this connection, as the initial producers of chips and service providers of IT infrastructures required to run AI applications respectively, Nvidia and Microsoft have benefited from more demand which should translate into more revenues.

Going ahead, they should continue to benefit from continued AI adoption, but, the market seems to have already priced in the additional sales and profit prospects as evidenced by QQQ's rich P/E. Therefore, in the absence of strong news like Nvidia's order book overflowing, do not expect much upside. On the contrary, geopolitics-led volatility can grind down its value due to its heavy concentration in tech, as illustrated below.

On the other hand, as seen by QQXT's much lower P/E, investors seem oblivious to the opportunities that AI can potentially bring to the wider economy. In this respect, due to the agility of SaaS or Software-as-a-service, any company, whether it is operating in the real estate, energy, or industrials sector, can rapidly avail the latest technology without needing to invest massively on an upfront basis.

Finally, to substantiate eventual benefits to various industries, I have used data from the research firm McKinsey to both quantify potential benefits and to value the ETF at $85.84, which is a modest target but a reasonable one considering that QQXT has 33% exposure to Consumer Discretionary and that sentiment has improved. It also has 22% of its assets dedicated to Healthcare, a more recession-insulated sector.

For further details see: