2023-11-17 17:16:35 ET
Summary
- High-beta securities have rallied after the Federal Reserve paused its hiking cycle, signifying a good time for tactical allocation to the tech sector.
- The iShares Global Tech ETF (IXN) is heavily concentrated in US tech equities and is currently testing long-term highs.
- The improved economic outlook, strong earnings projections, and potential pause in the Fed's tightening cycle support an allocation to tech and support a bullish view on IXN.
Investment outlook
The market has begun to display a new character after the Federal Reserve decided to pause its hiking cycle at its November FOMC meeting. The majority of high-beta securities and investment vehicles have rallied to retake their October highs after nudging monthly lows only weeks before.
A new flame of risk appetite has been ignited amongst investors of global equities. Leading the charge on aggregate, like the past decade, are tech companies. In fact, the snapback rally observed rolling into November provides ample evidence it may be time for tactical capital allocation to the sector.
The question then turns to which of the many avenues to employ when allocating capital to tech in the equity risk budget. One can own the individual securities leading the list. One can also own selective instruments that track the performance of the sector. For added diversification, there is scope to own instruments that invest in the global tech universe.
On face value, The iShares Global Tech ETF (NYSEARCA: IXN ) fits the bill of the last point on diversification. However, unlike its name suggests, the fund is heavily concentrated in US tech equities. It tracks the performance of the S&P Global 1200 Information Technology Sector Index, made up of global equities within the global technology sector. However, the fund is constructed by using a representative sampling method.
Price returns for the fund have been commendable over multiple time frames. In the last 12 months, its market valuation has increased 34% and over 40% in the last three years. Its recovery from the 2022 sell-off has been commendable, and it is now testing long-term highs. Moreover, IXN has rallied fiercely with the change in market character after the feds meeting. It trades above its 200DMA and its 50DMA, two critical inflection points.
Critical investment facts that form IXN's economic value:
- Holdings and assets under management
- The fund's weighting is entirely tilted towards US Tech equities despite its "global" label. The top 10 holdings comprise 63.5% of the portfolio. Microsoft and Apple, the two top holdings, make up around 42% of the total weight. There are 130 positions in total.
- IXN has $3.77Bn in assets under management and charges an expense fee of 41 basis points on this amount.
- Distributions, performance
- Dividends are paid semi-annually at a rate of $0.35 per share in the TTM and currently yield 0.55% at the time of writing. The fund has increased its distribution payments at a 5-year growth rate of 9.2%. Even though dividend growth has been lumpy, IXN has paid dividends for 18 years consecutively.
- It has a tracking error of 14.3% to its benchmark over the past year and 11% over the past 3 years. Turnover of securities is a standout, with just 12% of the portfolio turned over annually. Suitable for a concentrated fund.
Momentum in technology stocks has been tremendously strong in the past weeks, with potent signals indicating a bullish period of growth could be on our hands over the next 6 to 12 months. In my opinion, there is scope to allocate capital to a set of diversified technology holdings to capture the risk premium that investors are currently paying for. IXN is a more highly levered play to capture the tech rally that could last the next 6 to 12 months. This is a concentrated holding even though we have 130 positions built in the portfolio. But this very nature means early returns of a long position could be magnified. In regards to this, my recommendations for the three investment horizons are as follows:
- Fundamental: bullish over all three horizons, short term long term
- Technical: bullish over all three horizons
Net-net, I rate IXN a buy for the reasons discussed in this report.
Figure 1. IXN long-term price evolution—We are now:
(i) Above 50DMA + 200DMA,
(ii) Testing July + 2022 highs
Data: Updata
Talking points
Three fundamental crosscurrents support an allocation to take on the tactical side. These include (i) an improved economic outlook, (ii) Q3 earnings and forward projections, and (iii) a reignited appetite for risk assets as the Fed looks to have potentially changed its course.
- Improved economic outlook
The critical macroeconomic driver for markets remains the inflation/rates axis. The latest data has indicated potential short-term success with the tightening of financial conditions in response to the decades' high inflation numbers.
It has been particularly resilient on the growth side. For instance:
- GDP growth is set to be consensus forecast by two percentage points in the US, as inflation has cooled off its 6% handle in 2022 to a more modest, but still above target 3%.
- The recession risk has also shown signs of cooling. Those at Goldman Sachs have lowered the recession probability to 15% in the US, in a note from November. In fact, sees "several tailwinds to growth in 2024" , ranging from household income growth and a lower impact from fiscal tightening.
- In a separate note , the firm also believes that the hard part of the inflation fight may be over. The major to this, it says, is the geopolitical risks and a potential spike in oil prices.
- By all measures, it projects a 1.8% growth in GDP in 12 months to Q4, driven by growth in disposable income and consumption.
Figure 2.
Source: Goldman Sachs
As a result, the firm expects reasonably high returns on risk assets such as global equities. And in my opinion, the high beta portions of the market represent compelling value to participate at the forefront of this reversal rally.
Figure 3.
Source: Goldman Sachs
- Q3 earnings indicate tech leading the growth + reinvestment trail
Third-quarter earnings surprised to the upside for multiple sectors, but tech and communication services lead the way. According to FactSet analysis, 91% of communication services and 90% of information technology companies reported earnings above consensus estimates. The communication services and technology sector also reported earning growth of 42% and 11% YoY, respectively. Both sectors also had some of the highest profit margins in Q3, with tech at around 25% of earnings to sales and communication services at 13%.
The other factor is earnings forward growth projections. Per FactSet, analysts are projecting Q4 earnings growth for S&P 500 companies of 10.5%.
Critically:
(i) Communication services expects to report a 20% YoY growth in earnings,
(ii) Whereas technology is projected to do 15%.
So technology as a whole is leading the creation of value for the US markets and is projected for above-market earnings growth. For stock returns over the coming 1 to 3 years, this has significant implications, as investment returns are heavily impacted by sales and growth over this time. I am therefore bullish on IXN based on these investment facts.
Figure 4.
- Market changing character
Tech has led the charge in the latest drive in broad equities. Those funds and investor portfolios heavily weighted to the sector will have enjoyed a tidy tactical return this month.
If the last decade has taught us anything, it is this: investors will pay premium multiples to participate in the growth trade. When markets rally, so do aggregate multiples. Investors ask for higher prices to sell their securities to hungry investors.
The question is how high is too high for starting multiples to still recognize a decent investment return in the next 12 months. For context:
- IXN trades at 24x earnings, around double the category average and a shade higher than the FactSet segment average of 17x.
- FactSet also reports that as of Q4, "Information Technology (25.6x) and Consumer Discretionary (23.0x) sectors have the highest forward 12-month P/E ratios. "
- In the same breath, the crowd at Goldman Sachs noticed that for the mega-cap space, " valuations do not yet look “bubbly” if expected growth profiles are delivered" . So we have high multiples that may be fundamentally justified if the underlying companies pull through on earnings and operational growth.
Figure 4a.
Source: Goldman Sachs
There may be additional support for a tech rally (and therefore allocation to IXN) if the Fed has, in fact, begun to pause on its regime of fiscal tightening. The question is whether rate cuts will begin within the next 12 to 24 months.
Figure 5.
Opinions on this are obviously mixed, but the general consensus is that the worst of the rate hikes may already be behind us. The drag on the economy from the higher rates environment will likely continue in 2024, but consider that:
- It looks like we don't need a recession to bring inflation down, which means that central banks would likely be looking to avoid a recession,
- If we do, in fact, avoid a recession, then the case for outperformance in US growth is strengthened,
- There is conviction that the FOMC could even deliver its first rate cut as early as Q4 next year, according to Goldman Sachs research. It then projects a 25 basis points cut per quarter until Q2 2026. It goes on to say that "[p]olicymakers in developed markets are unlikely to cut interest rates before the second half of 2024 unless economic growth proves weaker than anticipated".
So the case for allocating to risk assets (namely equities) and the high beta segment of technology has strengthened in the last few weeks or so. The market is pricing in a period of better business over the coming 12 to 24 months, and this appears well supported in the data of earning growth projections and macroeconomic drivers. For tech specifically, the three compelling points are the improved economic outlook, earning projections, and valuations still with headroom to grow. This is a bullish list of factors for IXN in my opinion.
Technical factors for consideration
1. Regarding momentum
Momentum is exceptionally strong for IXN at the time of publication. The fund has broken out above a three-waves-down move that was completed in October. It now trades above the 20DMA highs and lows. The bullish cross of the MACD and pivot in the parabolic SAR were early signals of the reversal. Needless to say, this is a very constructive technical setup.
Figure 6.
2. Price visibility + directional bias of trend
We have upsides forming to the $75s after the bullish reversal in November. This has seen price action breakout above the short-term 45° resistance line, and trade above the October highs. A break to $75 would be significant and should not be ignored, as the point and figure studies have eyed the critical levels in IXN well over the past two years.
Figure 7.
Data: Updata
Trend action—Observations:
- The range extension in November has seen us cross above the cloud to the upside. Both price and lagging lines are now firming in bullish territory.
- Along with the momentum indicators from earlier, the heavy buying volume was a key sign at A, preceding the price action. Volume often precedes price before a large range extension.
- We gapped higher by 2x, taking the previous highs of October and August with us.
- Here, I am bullish on the medium-term horizon (coming weeks).
Figure 8.
Data: Updata
Long-term view— o bservations
On the weekly chart, which looks to the coming months, we are also bullish above the cloud. After retaking the August high, we are now pushing towards the highs of 2022, which would be a major risk on move if it were to eventuate. This is at $65.70, a shade off where we trade today. Critically we are in a parallel trend to the bullish cloud, and the lagging line is also above the cloud to confirm the directional view. Investors should watch the $65.70 level for it to be retaken would be a majorly bullish signal.
Figure 9.
Discussion summary
In summary, the market's character has again shifted towards risk assets in the final quarter of the year. investors are again piling into equities after cash dominated the capital flows for the most part of 2023. The charge is again the high-performing basket of technology stocks.
Investors can harvest the risk premium the market is paying for in the next 6 to 12 months by positioning against a sensible choice of tech-based instruments. IXN is one such holding that provides a more concentrated exposure under the guise of a "global" portfolio of securities. This shouldn't be looked in a bad light however, as the concentrated positioning provides a more levered exposure to the sector without the margin risk. There are fundamental and technical supporting factors that suggest IXN is a fair allocation to the long account over the mid to long-term horizon. Rate buy.
For further details see:
IXN: Levered Tech Exposure To Capture Risk Premium Off The Market's New Character