The Many Dimensions of Technology ETFs and the Stocks They Hold

The US Stock Market, led by technology, has outperformed most expectations this year. Going into Memorial Day weekend, SPY, the most popular S&P 500 ETF, has risen more than 10%. That’s a very impressive number in the face of many of the best-known strategists predicting a down year for the major index in 2023. 

As impressive as that is, the largest ETF of most-quoted technology indexes, the Nasdaq-100, Invesco’s QQQ, rose 31% year-to-date heading into the Memorial Day weekend.  Semiconductors led the way with Van Eck’s Semiconductor ETF, SMH, recording a 45% year-to-date return, nearly 50% higher than that of QQQ.  SOXX, the iShares Semiconductor ETF, finished second among the Technology ETFs in this report with a 41% gain.    After that, the others that had superior returns for both YTD and annualized five-year returns were broader technology sector ETFs including, in order of magnitude of returns.  XLK by SSgA’s SPDR ETFs; VGT by Vanguard; IYW by iShares (Blackrock); and FTEC by Fidelity.  The Fidelity ETF has the lowest fee, 0.08%, while IYW is the most expensive. 

With technology leading the market, this blog focuses on the spectrum of Technology ETFs, followed by a quick look at a few technology stocks most highly rated by ValuEngine.  Most, but not all, are weighted by market capitalization which favors momentum stocks and can have concentration problems.  An equally weighted alternative is RYT, Invesco S&P 500 Equal-Weight Technology ETF.  Its performance for the Year-to-date and 5-Year periods is less than that of QQQ but still more robust than SPY.  Other technology ETFs focus on specific subindustries and subsets within the sector..  Most are narrower and more expensive than the broad ETFs.  The two ARK Investment Management ETFs, ARKK, ARK Innovation ETF and ARKW, ARK Innovation ETF ARKQ, ARKW, Ark Next Generation Internet ETF, are actively managed and have suffered recent struggles to post returns as robust as QQQ.

ETFdb.com, a leading ETF data analytics site, classifies 59 US-stock ETFs as in the Technology Sector.   The following table includes 37 of these, limiting inclusion to those that have had at least 5 years of history since inception. 

Looking forward instead of retrospectively, ValuEngine’s predictive model currently has at least one ETF in each of its five predictive categories.  As it turns out, the majority of these ETFs and the best performers on this list are all rated as 1 (Strong Sell) including all nine ETFs with 5-Year annualized returns greater than QQQ in the chart above. QQQ escapes our lowest predictive model rating with a 2 (Sell) rather than a Strong Sell. My analysis of the indicators supporting the model is that the price acceleration is not sufficiently supported by acceleration of earnings growth to prevent mean reversion in the upcoming 12 months.  A simpler way of saying it is that these ETFs and many of the stocks they own have gotten too far ahead of themselves.  When it comes to those components, ValuEngine’s valuation model isn’t any more positive.  For example, 27 of the 30 stocks held by SOXX are ranked as “overvalued.”

At the other end of the spectrum, most of the buy- rated ETFs by our model for one-year price appreciation have had more modest gains on a five-year annualized basis.  Almost all the ETFs in this group are internet-software and cloud-computing oriented.  The 5-rated (Strong Buy) ETFs include:

PNQI - Invesco NASDAQ Internet ETF – This ETF tracks a modified-market-cap-weighted index of Internet companies listed in the US.  Included in the index are software companies, search engines, web hosting or web design, and companies involved with internet retail commerce, as determined by the Consumer Technology Association. The index tames the exposure to mega-cap companies by capping the five highest-ranked securities at 8% and the remaining securities at 4%

PSJ - Invesco Dynamic Software ETF - selects 30 companies based on its analysis of risk factors, style classification and stock valuation, with the hope of outperforming the industry.  Specifically, stocks are evaluated based on five factors, such as price momentum, earnings momentum, quality, management action, and value. Despite including big names, PSJ's tiered weighting system shifts its focus to smaller-growth companies — more than 30% is allocated to small- and micro-caps.

XWEB – SPDR S&P Internet ETF - XWEB provides equal-weighted exposure to the internet segment of an index that represents the broad US equity market. The fund’s portfolio comprises of internet retail, software, and services stocks, as defined by GICS. Since XWEB focuses on internet companies within the technology sector, it avoids hardware and semiconductors.

The assets under management (AUM) of these 5-rated ETFs tend to be on the smaller side with PNQI the largest at $540 million to the $24 million in XWEB. 

There are several interesting ETFs rated 4 (Buy) in this group as well.  They include:

IGV - iShares Expanded Tech-Software Sector ETF – IGV provides diverse exposure to the North American software industry. The index redistributes its portfolio away from tech giants into smaller, more growth-oriented software companies.  IGV, rated 4 (Buy) is larger than all three 5-rated ETFs with 5.6 billion under management.

SKYY - First Trust Cloud Computing ETF - was the first ETF to offer exposure to the cloud computing industry, a narrow segment of the technology sector that involves a fast-growing application. SKYY is so targeted on cloud computing that it can be a useful tool for fine tuning portfolio exposure. It could also have appeal as a minor “satellite” holding in a longer-term buy-and-hold portfolio to complement core positions.  SKYY, rated 4 (Buy), has more than $2.3 billion in AUM. 

XSW - SPDR S&P Software & Services ETF – is an equally weighted XSW ETF that includes exposure to application software stocks, internet software and services companies, data processing firms, systems software manufacturers, IT consulting companies, and makers of home entertainment software.  XSW, rated 4 (Buy) is smaller than IGV and SKYY with $240 Million in AUM.

Switching the focus to underlying stocks, the technology sector’s highest market cap holdings, Apple Corp. (AAPL) and Microsoft Corp. (MSFT) are both rated 3 (Hold).  But the biggest price-moving components in the sector, semiconductor companies Nvidia Corp. (NVDA) and Rambis Inc. (RMBS), are both rated 1 (Strong Sell). NVDA has gone through the roof because its hardware is essential for further development to most of the established leaders in the Artificial Intelligence race.  However, along with a forward P/E of more than 100 and a 3^rd centile (97% stocks more undervalued) score in our valuation model, our predictive model forecasts a 10% loss. 

However, there are several stocks in the sector our predictive model likes.  The following stocks are all rated 5 (Strong Buy) and have market capitalizations of $4 Billion or greater.

UI – Ubiquiti Inc. – develops technology platforms for high-capacity distributed Internet access, unified information technology, and consumer electronics for professional, home, and personal use.

WIX – Wix.com Ltd. - develops and markets a cloud-based platform that enables customers to create websites and/or web applications. 

CDAY – Ceridian HCM Holding Inc., together with its subsidiaries, operates as a human capital management (HCM) software company in the United States, Canada, and internationally. It offers Dayforce, a cloud HCM platform that provides human resources, payroll, benefits, workforce management, and talent management functionality; and Powerpay, a cloud HR and payroll solution for the small business market.

This table presents a look at the data behind these stocks and compares them to 1-rated (Strong Sell) NVDA.  Two ETFs, the iShares S&P 500 Index ETF (IVV) and Invesco Nasdaq-100 (QQQ) are also used for comparison and benchmarking purposes. 

1. These technology stocks are all highly volatile and only NVDA pays a dividend but even that is minimal with a yield of less than 0.1%.

2. WIX is the least volatile and NVDA is the most volatile stock. WIX is also the most undervalued by our model and has the largest projected one-year price appreciation from the predictive model.  UI is rated second in both valuation and forecast price appreciation.  Both amounts are a very close second to WIX.   

3. Although technology stocks may continue to drive the market during the remainder of 2023, the model’s predictive ratings of the semiconductor and technology ETFs along with the Strong Sell rating for NVDA suggest that active trader may want to ease up on those positions in favor of other S&P 500 sectors.  For those staying in the sector, the model suggests focusing on software, not hardware.  

4. Quantitative models, even ours, have limitations.  Chief among them is not knowing when paradigm shifts are about to occur.  One reason that some software and cloud technology companies may appear relatively undervalued is that the AI-focused market considers many of these companies vulnerable to being made obsolete given the more dynamic solutions that may be offered in the future by AI. 

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