ETF Edge - AI Trade Losing Its Sizzle? 8/21/23

Episode Date: August 21, 2023

CNBC’s Bob Pisani spoke with Jon Maier, CIO of Global X, and Todd Sohn, ETF and Technical Strategist at Strategas Securities. They dove deep into artificial intelligence, as the recently red-hot AI trade appears to be losing its sizzle. They discussed other practical applications across industries like infrastructure and cloud services. Beyond AI, the team also broke down a popular strategy this year using covered call ETFs. In the “Markets 102” portion, Bob continued the conversation with Todd Sohn from Strategas Securities.  Hosted by Simplecast, an AdsWizz company. See pcm.adswizz.com for information about our collection and use of personal data for advertising.

The ETF Edge podcast is sponsored by InvescoQQQQ, supporting the innovators changing the world. Investco Distributors, Inc. Welcome to ETF Edge, the podcast. If you're looking to learn the latest insights on all things, exchange, traded funds, you are in the right place. Every week we're bringing you interviews, market analysis, and breaking down what it means for investors. I'm your host, Bob Pisani. Today on the show, we'll dive deeper into artificial intelligence. Is the recently red-hot AI trade losing its sizzle?

Looks that way in August. What are other practical applications AI might have across other industries like industrials, infrastructure, and cloud services? Plus, we'll talk, covered call ETF strategies like those that Global X's users, which continue to pull in money. Here's my conversation with John Mayer,

CIO of Global X, along with Todd Sone, ETF and technical strategist as Stratiga's securities. John, you're two big ETFs, were huge outperformers in the first half of the year, but they've sunk in August. So what's the problem? Are we dealing with valuations? Are we dealing with interest rates? Is it China?

What's the issue? Well, certainly performance is really strong. Interest rates are certainly causing the markets to kind of take a second look. But if you actually look at the components in some of these ETFs, and they work really nicely together, bots has a large component of industrials. Industrials are companies that can help other companies enhance their efficiency. You look at the CAPEX cycle, it's been super strong. Companies are investing in themselves.

So if you look at some of the key holdings in bots, intuitive surgical, Keynes, Dinotrace, those are going to help other companies improve in terms of automation. And I think that's something to really focus on. It's not really about all artificial intelligence. It's a component, certainly. Yeah, I want to focus on this because by NVIDIA was the answer to every AI question in the first half of the year. But what I like about bots is there are broader potential beneficiaries. So the robotics and artificial intelligence ETF has some suggestions here.

I want to just go over them. Intuitive surgical. And you're right. These are plays on improving efficiency. I think that's a great way to talk about it. Intuitive surgical. This is a robotic automation, right, for surgery. Yeah, healthcare surgery.

And, you know, AI plays into that. The more information, more data points you have will improve the overall surgery, and that will certainly feed into the technology from intuitive surgical. You also have other companies that have sensors and barricing. codes, you know, Dinotrays and Keyance. Dynetrae does software intelligence in general, right? Keyance is industrial automation, essentially robotics. Exactly.

And Fanuk is another large component, which is industrial robots. Yeah, it makes a lot of sense to me. Todd, you watch ETF flows very carefully. There still seems to be interest in these AI ETFs, but other thematic tech have seen outflows this year as well. So it makes sense of this for us. There's inflows still in AI, ETFs, but other kinds of thematic tech have seen outflows this year. Right, right.

I think bots has been a beneficiary of this, right? They've seen strong inflows as investors realize they need AI exposure, right? I'm sure there are managers whose clients want the exposure to this theme because of its potential. But for the broader market, I think it's very odd and peculiar that tech ETFs have had outflows, right? The XLK. you talk about ARC, the innovation suite has out of flows, that the behavior of investors is not in sync with the market, right? The NASDAQ 100 at one point was up 40% this year, yet is not being embraced like it was back in 2020 or 2021. There's no euphoria this time around.

But this is part of the keys of behavioral economics. People don't buy low and sell high. They actually do the opposite. So last year, ARC had inflows in a terrible year. This year, August accepted, ARC's been very. performing great and it's had outflows. So how do you, I mean, am I right to look at this as a behavioral economics thing? I mean, why are people souring on Arc when it's had a good year?

Absolutely, I agree with you. I wonder if there are those who were burned, maybe they bought on the way up in 2020 and are now just trying to get out with this rally, perhaps trying to buy the dip last year, not realizing that we were in a very difficult environment between interest rates and inflation. And now they're saying to themselves, they're thrown in the towel. Let me look elsewhere. Let me maybe perhaps go to AI and say, said more strictly exposed base there.

I also think there's a recency bias. I think last year you would think there would be a follow-through. Yeah, there'd be a rebound. Once the rebounds occurred, then, you know, you're getting a little further away from it, starting to realize what's going on in the world, China, interest rates. Then, you know, perhaps you're pulling back at potentially the wrong time. So by reason to be a bias, you mean individuals see what is immediately in front of their face. Yes.

the most immediate things. And when you start out the year, you're down 20 percent, you're starting to sell into it thinking any rise is good I want to get out. Yeah, pretty much. Yeah. Now, you have another AIETF. It's a bit more mainstream. I want you to talk about this. This is the artificial intelligence and technology ETF. AIQ is a symbol. But it's got Amazon, Alphabet, IBM, Cisco, meta, Adobe, Alibaba. Everything's 3% in the biggest. And there's a reason for that, right? There is because there's a cap on the weighting upon the rebalance. So if you think about what drove the market this year, the Magnificate 7, whether it be in the NASDAQ or the S&P 500, you don't have caps on there. Their market cap weighted. The price of Navidia goes up. It's obviously a higher exposure in the portfolio. Upon a rebalance in AIQ, while it has many of those same names, you get rebalance to 3%. So you don't have as high of a concentration in those names. But those names are really important in the AI space because you think about what's driving AI. it's data. Data is super important. These large companies have exposure to data or the hardware

component. And that's right now what AI is while we're trying to figure out where AI is going. And I think this is so important, Todd, that AI really is play on efficiency. I would say productivity. So all those people, and it's really just another new technology that exists, where technology has been improving efficiency and replacing jobs for hundreds of years. You know, we sold this. I always liked the joke when I was a college student. I was a telephone. phone operator. And people were calling to the building. I want to talk to room 210. I take a court out, put it in. And that went away. That job, that was 50 years ago, that job was automated, out of existence. It was more efficient to do software than to have me stand in there,

plugging in. And this is what's happening now. Back office functions will come down. Software as a service has been doing this for 20 years already. So, for example. The interesting part of this, and John mentioned it was some of the companies in BOTZ. You're talking about productivity is the industrial's benefit. I think that's under the radar story. Everyone, not everyone, but most people believe AI is a tech play. Well, industrials as a sector have done very well over the last 10 months or so, and so I think you're starting to see that play out among the securities John mentioned and then other parts of the sector too. Yeah, there are industrial companies like Eaton and Ingersoll Rand that are now considered sort of plays on improving efficiency. There are anything involved

industrial automation or power generation. You know, more efficient. used products on Ingersoll Rand and Eaton are part of that. They've been moving up, outperforming, and I think partly on the perception that they can do better. You can get overweight industrials pretty easily. It's, what, 9% of the S&P 500, so if you want it to skew towards that area, it's much easier to do than 28% of technology. I still go to the problem of any pure play stuff that exists around this. Are there any private companies out there that AI potential?

Do you give me any names? Yeah. If you think about it, first of all, the AI space has been concentrated in those magnificent sevens. And so there's a lot of private equity money going into different companies. Now, one company that comes to mind is CoreWeave. That actually buys GPUs and rents out the space. So, Navidia is selling to many of these large companies like AWS, but AWS is a competitor. CoreWeave, they're looking for smaller companies where they're giving the opportunity to other companies

to use the G. To buy the GPs, to use the GPUs. I'm talking about in the video. Is this a cloud business, essentially? I mean, is this like a mini-A-WS? It's a rental opportunity in a sense for the GPUs. So smaller companies that can't buy, pay $40,000 for, or can't even get a GPU are renting the space from Correweave. The revenues went from $30 million to $600 million in one year. A very, very, going to be a very profitable business. It's not going to be a standalone just to this company. Are they thinking of going public? I have no idea. I would imagine so at some point.

It makes sense. Anybody else out there? That's a good one to watch though. Within the cloud space, well it's not necessarily private companies, Freshworks, it's one of the holdings in cloud computing, which is very important to AI, because if you think about what's needed for AI, the data. Data component is huge. Where do you store that data in the cloud? So cloud companies can really benefit from the AI revolution and are. So GlobalX, I want to move on a little bit here. GlobalX launched some of the very earliest thematic tech ETFs. I remember having you on ETF Edge five years ago, 2018 and 19.

You did electric vehicles. You did drive, cybersecurity, bug. You did cloud computing, CLOU. And they're all down in August. Again, it guess it's the same question here. Interest rates higher. A little bit of overvaluation. maybe some China issues at all?

What do you do? Because a lot of people piled into this stuff. This is the problem I have with thematics in general. At the top, you pay a lot of money because the interest is high. Sure. And it tends to move down over time. And that's the problem with these long range. You know, this is Jack Bogle in me saying, you know, this stuff, Bob, long term, revert to mean, you know.

Yeah, you know, thematics are an area that can move up fast and can move down. So we do say you should take a longer-term investment horizon for thematics, five to ten years. That being said, interest rates certainly impact the cost of capital for these companies, and that could reduce margins. But there are also secular themes that are undeniable. So when you think about cybersecurity, you look at Palo Alto today where the stock is up a meaningful amount on earnings, revenue misses, cybersecurity is super important to both cloud and AI. They all have to coexist in this ecosystem.

So that's important. So you have to take a longer-term view. Going back to electric vehicles, the electric vehicle adoption is happening. You're seeing the sales of electric vehicles go up every single year. The chart goes like that. Will you get a negative quarter, a negative year? Certainly. But direction, it's moving in one way.

Yeah, it's an important thing. Todd? I think thematics can be. difficult to get the entry and exit right. But the silver lining is, let's say there's a name you like, whether it's a Tesla or Rivian, but you don't want to get too concentrated. The thematic ETFs allow you to at least spread out that risk among the competitors. And so if the whole space starts to eventually work, then that's also to your benefit as an investor. Of course, the Jack Bogle, when we say, why don't you just buy XLK and on the whole technology space. But you may not have the

right exposures you want there. That can be dominated by Apple and Microsoft. The small stocks might not. Yeah, That's a good point. So just talk 30,000 point of view here. Where is AI heading? What's after hardware? Is it really an infrastructure play? Is it software services? How about AWS?

How about Amazon? How is it using AI? How is it being integrated? Well, I think we're in the early, first of all, AI has been around since the 50s. What's new is that AI is now available to the public. Chat, CheapT, brought it into our domain to talk about, How are a company that's going to use it and use the technology for efficiency?

And I think that's the real story is efficiency. It's going to be embedded into almost every business that we think of, whether it be from the law profession to health care. Doctors can use it so efficiently to diagnose and prescribe the right medicines. It's going to take that time away and provide that time for patients. There's so many different uses for AI. And I think we're still in the stage of how do you effectively use it? it. And that's why you've only seen the kind of like these seven companies. I'll pay what I want,

and I've been waiting for 10 years, a personal digital assistant. I want Bob.combe, personal digital assistant. I'm going to Miami. What's the most efficient flight to get down there? I'm going to California. Can I fly in a Santa Barbara? Stupid things like that. It's amazing how much time you spent chasing around little things about just managing your life. So I want a personal digital assistant to manage my life. Now, I know the risk is it's going to know more about me than I do eventually. Eventually, but I think if that's happening, if you think about chatbots and how you go on some of these websites and they're so inefficient, you're like, you get frustrated by the

answers. Generative AI is going to make it so much more efficient. They pop up all the time now. How can we help you? But it's going to be so much more efficient because they're learning from these conversations, learning from your information. Too much information, maybe at some point. But we're going to be in a world that you'd see AI or not be involved.

I mean, it's going to be binary. Let me just move on here. Todd, one of the more interesting flows to watch this year has been covered call. ETFs. These own an index like the S&P 500 or the NASDAQ 100, and they sell calls. So you get a little bit of premium and some downside protection. So these ETS, you have them, the Global XYLD and QYLD, they're continuing to pull in money. But the funny thing is they tend to underperform it at up market, which is what we've got. So explain this to it.

Todd. They have a dual. Again, this is that behavioral economics problem I see here. Money keeps going in and up market. I would love to know the demographics of who owns covered call funds, whether it's the Global X, the JPMorgan products, or the ones out there. You're getting the income, right, each month and the protection against major drawdowns, right, even though it's a little bit more low value, you're going to trail in a major bull market. But that fits the profile of, say, an older investor closer to retirement. Right. So I think that That's the appeal of those funds for a lot of folks out there. So you think it's not just, they're probably aware that it would underperform in an

they just want some protection long term. They're buying like an annuity to a certain extent. It's not really an annuity, but they're buying some protection in some way. Well, a cover called fund works best in a range bound market. You're selling your upside. And you're limiting your downside to the extent the premium received from the option premium. Now, some of the QILD XYLD yields are in the 12% range. That's very hard to give up, particularly for an older client.

But you'd be surprised. There's a lot of younger clients who are actually buying these products. If you look on Reddit and TikTok, there's kind of a cult following for some of these products. Because the downside protection and they still have a high yield. The yield is really the story. There's certainly downside risk, of course. But they do understand yields are not magic money. This is the hard thing I have explaining to people.

People somehow think that, oh, I'm getting a 3% dividend yield on my stock. It's like free money, but it's not. It comes at an expense. Of course, there's no free lunch. But it's still hard to give up a 12% distribution. That looks like an amazing number. It looks like free money to a certain extent. People love income, especially when inflation is where it's at

and expenses are going up every day. Yeah. Let me move on. GlobalX recently launched two actively managed funds to invest in two of the world's biggest developing markets. The GlobalX Brazil active ETF, the symbol is BRAZ, and the GlobalX India active ETF, D-I-A. Tell us about these. This is interesting. Again, I'm not a big active guy, but these are two

big, big markets. India is a huge market. You think about, yeah, there's $1.3 billion people in that market. The middle class is moving up. The barriers to have factories in India is easier than some other countries. It's a politically friendly country to the West. So there's a lot of opportunities in India. The actual capital markets are a little more different. to access, but this is a space where we feel active is certainly a better place. When you say active, what's active about it? Who's managing this? We have a portfolio manager who's actually looking at analyzing individual companies within the space. And you're looking for what? What are the factors here?

We're looking for growth. We're looking for stability. We're looking for increased market share, you know, all the usual aspects you're looking for in particular company. So we think because of the demographics of the country, because of the political situation in the country, we think it's a great place to be. This story makes complete sense. The problem is an efficient market, we all know this, right? But this year, emerging markets have had a tough time. I love the idea of active EM because the MSCI emerging markets index is so warped right now. By China? It's become a disaster zone at this point.

So I think if you're going to play international, particularly emerging markets, you have to do it actively. That benchmark doesn't work, and investors continue to allocate it still, despite it going nowhere for 15 years, despite the underperformance. And so I think every issue out there needs to be paying attention to what global extras did in looking at these as an active play at these markets. Doesn't it? But just to defend indexing, if you're just a China investor itself, China market long term may actually do fine. It's decoupling now, and that's a major problem for the West, for China investors. The stat I always like is China over the last 30 years is annualized at less than 1% per year. So you've basically made no money there. It's such a boom and bust vehicle.

Now, I understand the story, the growth story there, but when you look at it statistically, it just doesn't really add up to the attention it gets. Any thoughts on where we're going for the rest of the year in the emerging market space? I think selectively in emerging markets makes a lot of sense. China certainly has a lot of headwinds. So when you decouple from the major indexes, I think that's important. It's easy to sell India as the outsourcing for the world here. It's moving from China to India.

Vietnam is too small to handle computers. Maybe you can handle sneakers. It can do Nike. But, you know, Vietnam can't handle Apple, for example. Only India can handle Apple. It all goes back to the Cappex story and the reshoring and the friendly shoring story. And India is certainly a beneficiary of that story. So, yes.

Yeah. Well, let's keep an eye on all this. folks, because, again, you have the emerging market issue, you have the strong dollar, and you have the active. That's a lot of factors that can affect your performance. But it's still interesting to follow. Now it's time to round out the conversation with some analysis and perspective to help you better understand ETS.

This is the Markets 102 portion of the podcast. We'll be continuing the conversation with Todd Sone from Triticus Securities. Todd, thanks for sticking around. I wonder where you think we're at right now. We had a great run going into August. We're off 5%. I keep pointing out it's seasonally light volumes. I don't see anybody heading for the exits.

I just see buyers not interested in buying more. I don't see heavy selling. I see the VIX at 17 or 18. That's not panic territory. So internally, I don't see a lot of cause for concern at this point. But there's an old saying the first 5% is slow because everybody buys the dip. But the second 5% is often a lot. faster because they stop buying the debt.

Yeah, I think this is a great spot where ETFs come into play because there are lens into the psychology of markets, right? You mentioned the second 5%. Maybe that's the catalyst that interest rates are starting to hit right now, right? You have a 10-year at 434 or so. That's a multi-decade high. And what I'm looking for is, are there more outflows from equity ETFs, right? August month to date, you've had about $3 billion or so in outflows from equity ETFs.

That's pretty rare with a week and a half to go. I want to keep an eye on volumes into leverage short ETFs. I want to keep an eye on spy volumes, right? That's going to be reflective of more anxiety coming into the market. We're not quite there yet. But the flow backdrop has cooled, which is helpful. That's early signs of sentiment shift. And I would also just keep an eye on the amount of money going into cash like bond

ETFs. Last Thursday you had over $1 billion into T-bill ETFs, which is very rare. So there again is that sentiment coming into play that people are getting a little bit more nervous here as the market starts to continue. It is quite remarkable to me that there's so much money into these T-bills, money-market funds still. I mean, you're getting 5%. But the S&P is up 16%.

15% this year. A rational investor would look at that and get FOMO, but I guess there's a lot of people out there that aren't that worried about it. When you look at headlines, as I think my business. majority of investors do, they get scared and they go to the safety of money market funds. I think it's amazing that we're almost six months since the regional bank fallout, right, last March. There's been $750 billion in the money market funds since then. That outnumbers any other asset class by far. That's a 15% change in assets under management

for money market funds. That is one of the top readings in the 30 or so year history of money market data that I have. Now, if equities start another run higher here, does that much money finally start to come out. I'm just not sure. I think ultimately it's going to take interest rates immediately lower before you start to see money really flow back into stocks. So what happens for the rest of the year? I mean, we're all, everybody's nervous about Powell. He's going to be speaking Friday at the Jackson Hole conference. A month ago, everyone was thinking, well, he's going to be on the doveish side. Hopefully we'll get some guidance on we're done this year or maybe even talking about when they might feel the need to cut rates. And now that's

all changed because of the strong economic data, there are people who worry he's going to sound just as hawk as he was at Jackson Hall last year where he basically came out and said, you all don't understand what we're doing here. We're going to keep raising rates. And now he's going to say the same thing except he's just going to say, we're going to be higher for much longer than you people think. So that seemed to be a big problem. We're in a news vacuum. He's the only thing on the plate for the next couple weeks. So when you were in these corrective phases, any sort of negative word or a negative connotation is enough to upset the markets. And that's the potential for later this week.

The market will dissect every single word that the chairman says. But I would zoom out and consider that we're 10 months off the October lows for the S&P 500. Trends are ultimately firmer than they were a year ago, right? It is a bull market. When you start to get oversold conditions in bull markets, that's typically when you want to step in. It can be hard to time those, the entries and entrance of this. But I think we should remember where we just came from. The NASDAQ 100 was up 40% at one point.

It was 25% above its 200-day moving average. That is historically rare, and you can get speed bumps like we are right now. But it also does mark major lows over the course of history when you get that stretch from trend. So I think that's what a measure. Say it marks a low when you get what stretch? When you are 25% above the 200 average on the NASDAQ 100, That's an extreme level reading. And it's marked every low going back the last 40 years that the index has been around.

Now, you can get short-term speed bumps, mean reverting plays. But I think investors need to keep that in mind as this conference comes up. I'm sorry, because I think you said something important here. When you are 25% above the NASDAQ 100-200-day move, which has happened recently. Happened early to some. That's the top usually. And that's exactly what's happened, right? Yeah, short-term top.

In the beginning of August, you mean it was? Yes. But it also is consistent with coming off of important market lows like we did back in October, or in March 2009 or 2003. You mean the market overshoots. It just keeps... Yeah, exactly. You overshoot.

There's this emotional response that we've made it out of the woods, and then you get a little bit of a shakeout. And ultimately, once that shakeout ends, you should resume higher. And then let's take that into account once we get into the fourth quarter, the seasonal backdrop gets better. We'll see what the economic data is. We'll see how the Fed talks. But ideally, things should be an asset for the Bulls then. And when you're giving advice at Stratigas on ETF allocations, how granular do you get?

We just had a big discussion with John Mayer about thematic tech ETFs, which was all the rage in 2016, 2017, and 2018. And it sort of died down a little bit because, well, because they're four or five, six years old. there's a story. I'm talking about cloud computing, talking about cyber security, I'm talking about autonomous vehicles. So a lot of the early hype is done. And this is the problem I have with the ETF business in general. They jump on the newest fad. You're buying in at the top and then interest wanes over time. Yeah, that is a liability of thematic ETFs. It's timing when to play them

correctly is really challenging. And there's so many out there now that, okay, well, do I buy cybersecurity? Do I buy EV? That's really hard. I think their benefit is to complement a portfolio. If you have a client that says, hey, you know, I do want the EV or the cybersecurity exposure because there's companies that aren't in the S&P 500 there. That's the benefit for the long run. Yeah, I see that benefit. Small companies that aren't in the S&P 500 that are harder to get exposure to. It makes a lot of sense. Or even international, too. You think about Some of the robotic ETFs out there, they have plenty of non-U.S. companies. Okay. Todd, Stone, thanks very much for joining us. Really appreciate your thoughts.

Todd Stone is from Stikis, and thank you for listening to the EPFH podcast. Inves QQQQ believes new innovations create new opportunities. Become an agent of innovation. InvescoQQQQ, Invesco Distributors, Inc.