These 3 AI ETFs Could Be the First to Kill the Stock Market Rally
The AI-driven rally has reached a fever pitch, but a look under the hood of three primary ETFs, the iShares Semiconductor ETF (SOXX), the iShares Top 20 U.S. Stocks ETF (TOPT), and the U.S. Digital Infrastructure and Real Estate ETF (IDGT), reveals a market that is fundamentally overextended and structurally vulnerable.
While momentum remains strong, these three ETFs exhibit charts that I simply label as “stretched.” That is, they have moved up so far, so fast, that the laws of gravity are as big a risk as some out-of-left field news event.
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The lesson of 2000 and the dot-com bubble is that you never know how high a momentum-driven, narrow rally can go. But we can know when risk is at least competitive with the potential for continued reward. These charts suggest they will be the first to break when the current wave of euphoria finally hits a wall.
Here’s a summary of the trio. They are all up smartly this year and over the past 12 months.
SOXX
SOXX is the clearest example of a parabolic move that has detached itself from historical norms. The semiconductor space is no longer trading on cyclical fundamentals. It is trading on pure AI mania.
With a trailing price-earnings (P/E) ratio of 51x, the sector is priced for a level of perfection that rarely exists in the notoriously cyclical chip industry. When the semiconductor cycle eventually turns, or when the massive capital expenditure budgets for AI chips begin to rationalize, SOXX will likely be the primary engine of the downward wave.
When I see a stock or ETF do what SOXX just did (circled in purple above), all I think about is the Empire State Building, narrowing with a needle at the very top. Just as that skyscraper shoots up to a very sharp point, as does the SOXX chart, it comes right back down on the other side.
TOPT
Speaking of really big things, this ETF owns the 20 largest S&P 500 Index ($SPX) stocks. And if any ETF summarizes the extreme nature of the rally we’re in right now, it is this one. TOPT represents nearly 50% of the entire S&P 500. Think about that. 500 stocks, but 480 of them combine to be just a bit higher market cap than the other 20. That’s what I call a K-shaped market. Or maybe better said, an “i-shaped market.”
TOPT highlights the extreme narrowness of this market. While the fund is up a respectable 33% over the past year, its recent performance shows signs of exhaustion, gaining “only” 10% year-to-date. When 20 stocks dictate the direction of the entire market, the margin for error disappears.
A single earnings miss or a shift in regulatory sentiment for just two or three of these mega-cap titans can trigger a liquidation cascade that the rest of the market is too weak to offset. At a P/E of 32x, these top-tier names are expensive safe havens that are starting to feel crowded.
IDGT
IDGT is easily the smallest of the three. And also the most vulnerable, based solely on the chart. That PPO I circled above is ominous and very toppy. Up 50% over the last 12 months, this ETF tracks the data centers and physical infrastructure required to power the AI revolution.
The surge in this ETF so far this year obscures a growing fundamental risk.
As power grids reach capacity, and real estate costs for data centers skyrocket, the growth at any cost phase of digital infrastructure is quickly starting to meet physical reality. Despite a more reasonable P/E of 17x, IDGT is highly sensitive to rising interest rates and energy costs. If the physical costs of AI exceed the projected returns, this sector will see a rapid valuation reset.
A quick ROAR Score analysis of the three funds shows that while the alarm bells are not ringing this second, the moves that occurred as those ROAR Scores either advanced from higher risk (red zone) to higher scores (lower risk) over the past few months, the gains have been significant. What to look for next? Those scores dip to 40, then 30. That’s when we’ll know “it’s on.”
These ETFs are all stretched, and all vulnerable. But we can’t know when – or if for sure – they’ll fall. All we can say is that the risk here looks higher than usual.
I prefer to look at them as high risk, high reward tradeoffs. And that means either position sizing them smaller, hedging them, or at least accounting for that sudden increase in risk. If and when the trend reverses, these funds won’t just participate in the decline. They will lead it.
Rob Isbitts created the ROAR Score, based on his 40+ years of technical analysis experience. ROAR helps DIY investors manage risk and create their own portfolios. For Rob’s written research, check out ETFYourself.com.
On the date of publication, Rob Isbitts did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. This article was originally published on Barchart.com