Investors love exchange-traded funds and especially those with a certain theme or buzzword attached to them. Over the past decade and half, as markets have moved in a one-way line due to endless Federal Reserve quantitative easing, free money, this strategy has worked.
Indeed, fund companies/managers and ETF trackers have made lots of money setting up these “theme” tracking ETFs, charging a percentage of assets under management. Cathie Wood’s ARK Invest, and its funds such as ARK Innovation ETF (ARKK) , comes to mind in this regard. These ARK ETFs were the hottest thing since sliced bread back in 2020 through 2021, as AUM grew from a few billion, reaching highs of $50 billion, before collapsing now to around $12 billion. This can be classified as one of the greatest momentum-driven stories around.
From trough to peak, nobody had a clue what they were investing in or what valuation multiple was assigned to these “disruptive” technologies. While multiples got exaggerated, the performance became self-fulfilling as it was never really about the “fundamentals” but more about Fed policy. After all, aren’t these disruptive technologies still around today? If they deserve such high-growth multiples, then why are many of these names down 80% or more?
Sustainable investing also became “a thing” over the past few years. As we move to a world that desires a smaller carbon footprint and clean energy transition, this has become a prevalent theme in investors’ ETF allocation these days. What most investors failed to realize, however, was that these so-called sustainable ETFs had a large chunk of their assets in Apple (AAPL) , Amazon (AMZN) , Microsoft (MSFT) , Google (GOOGL) and other large-cap tech stocks that had been winning names.
No doubt, these ETFs grew by far due to the technology free cash flow, but it was for the wrong reasons. Low and behold, indexes got hit hard in 2022 as the Fed moved to quantitative tightening vs. quantitative easing. This begs the question how “sustainable” was this sustainable strategy?
Fast forward to today as artificial intelligence has taken the world by storm. There is no doubt that AI will change a lot of the grunt work we once used to do. The landscape for jobs going forward will rely on the right tools and regulation. Meanwhile, AI could become a detriment to school teachers who will now find it hard to convince students to do a research paper and use critical thinking as opposed to typing in a few command words at a computer prompt.
But if one were to look through the top-10 holdings of some of the so-called AI ETFs, once again the usual suspects come into play — Apple, Microsoft, Google, Amazon and Nvidia (NVDA) to name a few. Look, the performance of these large-cap tech companies has been impressive with their free cash operating models and some actually do have divisions focused on AI growth — but not to the extent being priced in by these ETFs. Once again, retail investors are not taking the time to see when the earnings can kick in or what multiple should be ascribed to them in the first place, be it five years from now or 10.
There is real merit in a cleaner energy transition, but to do so without a clear strategy risks fossil fuel production supply shortages at times when demand is at its height, like we saw last year. One cannot eliminate fossil fuel production or the value case in some cases. Just like blockchain or AI is here to stay.
Thematic investing makes sense when passive investing does well. But in a world that is dealing with inflation, higher-for-longer interest rates, and an economy on the cusp of hitting a recession, choosing stocks wisely makes more sense than blindly investing in a trend. Indeed, active investing may just be back in vogue as we have seen the broader indexes, especially like the S&P 500, being flat for over a year.
It is important to separate the theme from the companies actually positioned to benefit. Investors need to drill down on the ETF’s holdings list to see which ones make sense and which are just being used to garner more AUM using key buzzwords like the ARK funds did.
A breakdown appears imminent if traders don’t begin hitting the buy button for the iShares 20+ Year Treasury Bond ETF, and the S&P 500 Index could follow.
There are now two weeks until what we think is the deadline for getting a debt bill passed into law.
The result is a high level of uncertainty that produces choppy and inconsistent market action.
We’re seeing smugness in the big-cap tech stocks and bearishness most elsewhere. Let’s check sentiment and see what it’s telling us.
To put it bluntly, this is a narrow, terrible market environment right now.
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