PNQI: Elevated Inflation Is A Threat For High-Multiple Tech Stocks – Seeking Alpha

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Internet giants have dominated the market over the last decade and have handsomely rewarded their shareholders. The industry was recently boosted by the COVID-19 pandemic when the world entered into lockdown, and the global population relied on the Internet more than ever. However, I believe we are at a pivotal point for Internet stocks. The recent economic data in the United States points to a strong labor market coupled with above-average inflation, which should push the Fed to raise interest rates and begin quantitative tightening. That said, the US is not the only region of the world where inflation runs hot. This week, the BoE raised its base rate to 0.5% and the ECB turned hawkish amidst higher than expected inflation. The reason why economic data is important is that it has a direct impact on the stock market. Equities, which are considered long-duration assets, will soon be discounted at a higher rate. As a result, there is a clear risk that valuations will take a hit. Particularly, I expect high P/E stocks to suffer the most going forward. In my opinion, Internet companies are richly valued at the moment, which puts investors owning these stocks at the risk of a higher drawdown when compared to the overall market. In this article, I will review the Invesco NASDAQ Internet ETF (NYSEARCA:PNQI), which provides exposure to a basket of companies engaged in Internet-related businesses.
The Invesco NASDAQ Internet ETF tracks the performance of the Nasdaq CTA Internet Index. The index is designed to track the performance of companies engaged in Internet-related businesses that are listed in the US. These companies are involved in Internet software, Internet search engines, web hosting, website design, or Internet retail commerce as determined by the Consumer Technology Association (CTA).
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From the sector allocation chart below, we can see the index places a high weight on the Communication Services sector (representing around 39% of the index), followed by Information Technology (accounting for 29% of the index) and Consumer Discretionary (representing around 26%). The largest three sectors have a combined allocation of approximately 94%. As the strategy suggests, this portfolio has a high allocation to tech. In my opinion, it is important to see how that fits your diversification goals and if you are comfortable with a higher allocation to tech, which can in turn increase the volatility of your portfolio.

Invesco
The top ten countries represent approximately 100% of the portfolio in terms of geographical allocation. The United States accounts for 79.19%, whereas other countries such as India seem to be underrepresented given the low weight (only a 0.07% allocation to India).

Invesco
PNQI invests over 63% of the funds into large-cap growth stocks, characterized as large-size companies where growth characteristics predominate. Large-cap issuers are generally defined as companies with a market capitalization above $8 billion. The second-largest allocation is in large-cap blend equities. It is interesting to see that this ETF allocates less than 20% of the funds to mid and small-cap stocks, which generally tend to outperform large-cap issuers over a long period of time.

Invesco
The fund is currently invested in 81 different stocks. The top ten holdings account for 60.49% of the portfolio, with no single stock weighting more than 10%.

Invesco
Since we are dealing with equities, one important characteristic is the portfolio’s valuation. According to Invesco, the fund currently trades at an average price-to-book ratio of 7.26 and an average forward price-to-earnings ratio of 41.05. In addition to that, the portfolio has a return on equity of 13.18%. I generally consider a company trading at a forward price-to-earnings ratio above 20-25 to be richly valued. Moreover, I believe we are at an inflection point in the market where the Fed is ready to raise interest rates and start quantitative tightening, which will put further pressure on valuations.
I have compared below the price performance of PNQI against the performance of the Invesco QQQ ETF (NYSEARCA:QQQ) which tracks the Nasdaq 100 over 5 years to assess which one was a better investment. Over that period, the NASDAQ 100 outperformed PNQI by more than 80 percentage points. To put it into perspective, a $100 investment in PNQI five years ago would now be worth $202.26. This represents a compound annual growth rate of more than 15%, which is a very good absolute return. Another interesting characteristic of Internet companies is the high volatility. Until recently the performance spread between the NASDAQ and PNQI was relatively small. However, the gap widened considerably from December 2021 when market volatility started to pick up.

Refinitiv Eikon
If we take a step back and look at the performance from a 10-year perspective, the results don’t change much. The Nasdaq finished once again on top and clearly outperformed PNQI. However, it is worth noting that PNQI delivered strong results and was outperforming the Nasdaq all the way until November 2021. I think it is pretty clear by now that you are at risk of higher drawdowns if you own PNQI. This has been the case on several occasions, especially during the 2018 pullback and the COVID-19 crash. Before you consider buying PNQI, I think it is important you have a clear risk mitigation strategy. One effective way to hedge risk is through the use of put options, although that might be expensive at the moment given the current level of volatility.

Refinitiv Eikon
PNQI provides exposure to a basket of companies engaged in Internet-related businesses. This ETF performed well over time, compounding at a double-digit rate over the last decade. However, it is important to highlight that the market did very well too over the same period of time. If we take the example of the NASDAQ 100, it has in fact outperformed PNQI. Given the fact that we are at a turning point in monetary policy in western economies, high multiple stocks, such as many constituents, are risky investments in my opinion for now. I believe it is prudent to wait for more clarity on monetary policy decisions and to see how the market reacts over the next 12 months before purchasing this ETF.
This article was written by
Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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