AI Momentum Takes A Breather, Spotting A Buying Opportunity In WTAI

The first quarter earnings season is on the doorstep. The big banks kick things off on Friday with JPMorgan (JPM), Wells Fargo (WFC), and Citigroup (C) posting profit results. Big tech doesn’t report until later in April. Something to watch for across all sectors is how often “AI” is mentioned on earnings calls. Goldman Sachs noted last week that a continued surge in AI interest dominated the corporate landscape earlier this year.

Both growth and value sector firms took part, and there are even data suggesting that citing has led to better share-price performance. While the AI theme has cooled lately, amid alpha from cyclical stocks since the middle of February, it remains a key driver of growth in 2024.

I reiterate a buy rating on the WisdomTree Artificial Intelligence and Innovation Fund ETF (BATS:WTAI). I initiated coverage of the fund last summer, outlining a ‘buy the dip’ strategy that worked out well given the market’s July through October correction. Today, momentum has slowed and there are technical risks, but this disciplined strategy looks solid over the long haul.

Corporations Remain Focused on AI

According to WisdomTree, WTAI seeks to track the price and yield performance, before fees and expenses, of the WisdomTree Artificial Intelligence & Innovation Index, which identifies companies that are primarily involved in the investment theme of AI and Innovation. The ETF offers investors exposure to companies offering AI technologies and firms contributing to the development and deployment of AI innovations. The ETF can complement a growth allocation with diversified exposure to artificial intelligence companies exhibiting high-growth characteristics and satisfy the demand for comprehensive, multi-sector access to the AI megatrend.

WTAI remains a small fund with $242 million in assets under management as of April 5, 2024. With a moderate 0.45% annual expense ratio, the ETF pays a small 0.24% trailing 12-month dividend yield. WTAI features solid share-price momentum, but its rise has stalled since the middle of the first quarter – I will detail the full technical view later in the article.

The portfolio is to the risky side, as evidenced by Seeking Alpha’s weak D ETF Grade but liquidity is decent. I encourage investors to use limit orders during the trading day given that the fund’s 30-day median bid/ask spread has averaged 10 basis points and volume is typically around 200,000 shares daily.

The 3-star, bronze-rated ETF by Morningstar sports some diversification across the style box. Of course, there is a heavy tilt to the growth side, but with about 40% of the allocation in the small and mid-cap space, there is exposure beyond mega-cap tech. The forward price-to-earnings ratio is lofty at 27.6, but that is merely on par with the S&P 500 Expanded Tech’s earnings multiple.

And considering its high long-term earnings growth rate and 20%-plus historical EPS growth, the valuation is not as stretched as you might think. Plotting high on the momentum scale and with high earnings quality, the fund’s current consolidation leads investors to spot the next favorable entry point. We’ll explore that later.

WTAI: Portfolio & Factor Profiles

WTAI’s P/E Multiple is Comparable to S&P 500 Expanded Tech

WTAI typically owns about 80 individual equities. But AI is not solely confined to the semiconductor industry. WisdomTree takes this mega-theme and identifies stocks across industries and geographies that are poised to reshape the way work gets done.

One niche in focus is Software. The issuer cites Natural Language Processing (NLP) and generative design as AI elements that can expedite drug-discovery development in the Health Care sector. Smart software that is more efficient than previous industry technologies and can predict medical outcomes by processing research quickly and flagging notations for doctors and researchers to investigate further can deliver real value and even save lives. The Health Care sector is a material 6.3% of WTAI to complement a high weighting in the Information Technology space.

WTAI: Top Holdings, Sector & Country Weights

The ETF employs a flexible and comprehensive approach to owning shares of leading AI companies. A mix of both quantitative and qualitative research goes into the index selection process. The four target areas are: AI Software, Semiconductors, AI Other Hardware, and Innovation.

1. AI Software includes NLP & matching translation, voice recognition & audio processing, chatbots & virtual assistants, computer vision & image recognition, knowledge graphs & intelligent search, machine learning & data science, and robotics process automation.
2. Semiconductors spans memory devices, compute devices, sensors, edge computing, and semiconductor manufacturing software & equipment.
3. AI Other Hardware houses autonomous vehicles, robotics, industrial automation, and drones.
4. More broadly, Innovation can include any disruptive application of the above technologies.

WisdomTree classifies each company the ETF owns in one of those four categories with a designated sub-theme. As of the end of 2023, AI Software and Semiconductors were the heaviest weights, with 33% of total exposure to the Semiconductor industry. Sixty-four percent of the fund was considered large cap at the turn of the year.

WTAI: AI Software & Semiconductor Exposure

The Technical Take

With a lofty P/E but also stellar EPS growth trends, WTAI’s rally has stalled. Notice in the chart below that shares are well off their high from mid-February. What’s more, the RSI momentum gauge at the top of the graph has printed a series of lower highs, even breaking down to a fresh five-month low near 40. That tells me that the pullback could have legs, potentially leading to a test of its long-term 200-day moving average. While price has dropped below the shorter-term 50dma, the 200dma remains positively sloped, which is encouraging.

Also take a look at the volume profile. The bulk of shares traded has come about in the past year. That makes the $16 to $22 zone all the more important. Currently in the upper end of that range, a retreat into the teens could certainly come about. I see support at its uptrend line off the late 2022 low under $14. Similar to the trade I outlined last August, a 10% drop would be a solid risk/reward buying opportunity with WTAI with key support near $17.50. A test of the uptrend channel’s lower bound would be healthy and would then set up a bullish run back up to the top end of the rising trend.

Overall, with ebbing RSI momentum and having come off a touch of its rising resistance line in February, a further consolidation or decline to support may be in the cards.

WTAI: Momentum Wanes, Spotting Support Near $17.50

The Bottom Line

While I have a tempered near-term view of WTAI’s chart, I see long-term upside earnings potential and I like WTAI’s construction methodology. Momentum is currently with cyclical sectors, but WTAI sets up well as its share price consolidates.