IWF Is Plunging, Sell And Rotate To Value (NYSEARCA:IWF)

As the US stock market begins experiencing a broader selloff in the tech category, I believe it’s an inflection point and investors need to adjust their portfolios to capitalize on the recent gains while preparing for a range-bound to negative broader market movement. The massive crowd momentum in the mega-caps appears to be ending because of slowing growth and lofty valuations. Therefore, I initiate coverage of iShares Russell 1000 Growth ETF (NYSEARCA:IWF) with a sell rating.

Risk of Significant Selloff is Increasing

CNN’s Fear & Greed index, which was in the greed to extreme greed range in the last eighteen months, is now swinging in the the fear to neutral range. The index mainly represents investor sentiment based on key technical indicators including volatility, moving average, safe haven demand, trends in the put & call options and market strength. Besides a few, the majority of these indicators signal a potential downtrend. For instance, CBOE Volatility Index, a gauge for measuring market volatility, recently surged to nearly its highest level in 2024. Similarly, the robust demand for junk bonds and safe haven assets in the past weeks also signals a shift in trading trends and investors rotation out of risky assets to safe assets.

While it’s true that buying when others fear could help earn big gains over the long-term, picking the right entry time is equally crucial. Buying a stake at the beginning or middle of a selloff does not appear like a smart move. Investors interested in buying a selloff should wait for the market to bottom-out, which I believe will take some months. Instead, it’s time to sell an existing stake in tech-focused ETFs like iShares Russell 1000 Growth ETF to capitalize on the recent gains.

There are numerous reasons to believe that IWF is likely to underperform in the second half of the year, including declining crowd momentum in the tech category. Retail investors and hedge funds were betting big on the magnificent seven and other tech stocks in the past eighteen months due to their explosive growth trends along with the potential impact of AI on their future performance. For instance, the software industry saw a whopping 60% price gain last year while the magnificent seven stocks made up more than half of the total S&P 500 returns. In particular, NVIDIA (NVDA) and Meta (META), were the star performers while the rest of members also contributed to the uptrend.

However, with declining forecasts and slowing growth compared to the previous periods, investors began selling their positions in mega-caps to capitalize on massive gains and allocating investments to low-beta sectors and categories. This is clearly reflected in the price performance of the S&P 500 compared to the magnificent seven in the past two weeks. In fact, technically, the group fell into the correction territory with more than 10% price decline from a record high on July 10. Historical data shows that indices generally take nearly four months on average to recover to previous levels.

Besides the growth, I believe valuations-related risk could also back the selloff in magnificent seven and tech stocks. Sharp gains in the past quarters have raised their valuations above the 2021 level. For instance, the forward PE of the information technology sector, which represents 50% of IWF’s portfolio, recently hit a two-decade high of 30x. Similarly, the mega cap-8 stocks are trading at 31x forward price-to-earnings ratio.

Sell IWF Before it’s Too Late

Falling in love with stocks or ETFs generally creates a behavioural and analytic bias. It’s true that the tech sector has a promising future but downtrends are also part of the game. Historical trends show that whenever a sharp rise in stocks lifts valuations to new highs, there comes a correction to fix the prices to their longer-term averages. After a strong bull run in the past eighteen months, it appears that the market is at the inflection point and there is likely to be a big correction in tech valuations, which could erode the gains investors earned on IWF. Therefore, selling a stake in the mega and large cap tech-focused ETFs like IWF appears to be a prudent strategy.

As more than half of IWF’s portfolio is composed of the magnificent seven stocks while the rest of the portfolio is dominated by large cap growth stocks, the ETF’s trailing PE ratio soared to 41x, almost double than the S&P 500. The ETF’s price to book ratio of 13.70 is also significantly higher. In the case of S&P 500 entering the correction market, the losses for IWF will be significantly higher given its lofty valuations and beta of 1.15. IWF has already lost nearly 8% of price since July 10, almost double than the broader market index. I expect the extension of the downtrend in the coming weeks because of slowing growth forecasts from the tech companies in their second quarter earnings calls. The recent losses for magnificent seven were also blamed on unimpressive results from Alphabet (GOOG) (GOOGL) and Tesla (TSLA).

Moreover, the broader selloff in the chip industry has also been contributing to the downtrend. As NVIDIA’s forward PE of 66x is highest among magnificent seven, it is at a risk of performing poorly if the management remains unsuccessful in impressing investors with growth numbers in the June quarter earnings call. The forward growth rate for its revenue and EBITDA is expected to be around 80% and 166% in the next twelve months, down significantly from 200% and 700% growth in the last twelve months. Similarly, Microsoft’s (MSFT) earnings growth is expected to decline from high double-digit to single-digit range. Meta’s earnings per share growth rate of 70%, which played a key role in a staggering 263% share price growth in the past eighteen months, is also expected to cool to a double-digit rate over the long term.

Value Investing Could be an Attractive Option

While the growth stocks and ETFs are experiencing challenges, the value category could be an attractive alternate option because of its ability to perform better in downtimes. iShares Russell 1000 Value ETF (IWD) reported a gain of 2.2% in the past two weeks, outperforming the broader market index and iShares Russell 1000 growth ETF by a significant percentage. The positive performance from the value category in the tech selloff reflects investors rotation out of tech stocks into undervalued value stocks. In addition, value stocks are expected to generate healthy growth rates in 2024 while underperformance in the past year make their valuation significantly attractive.

The iShares Russell 1000 Value ETF is currently trading around 18.5 times earnings and only 2.55 times book value. Meanwhile, the broader market index is around 21x earnings and the information technology sector around 30x. Its dividend yield of nearly 2% could also play a key role in improving investor return in downtime. A beta of 0.86 indicates its low sensitivity to the broader market index. The index is mainly composed of value stocks from financial, healthcare, industrial, energy, consumer staple and consumer defensive sectors. According to FactSet data, the healthcare sector is expected to generate 12% earnings growth in the second quarter while banks from the financial sector recently reported robust earnings. Meanwhile, declining inflation continues to improve profitability of companies in the consumer staples and defensive sectors.

In Conclusion

As tech stocks are expected to lose momentum due to high valuations and slowing growth, it’s a perfect time to capitalize on the recent gains by selling a stake in large cap tech-focused ETFs like IWF. Its concentration in mega and large caps from the tech category increases the risk of significant downtrend in the coming months. Meanwhile, shifting a focus toward low beta stocks and ETFs could help investors outperform the market in the potential volatility. Value category is among the best options because of its attractive valuations and healthy growth rates.