IAI: Betting On US Capital Markets Activity (Technical Analysis) (NYSEARCA:IAI)

Stock Market And Financial Figures - European Economy - Global Business — Stock Market And Financial Figures

DKosig

Introduction

One way to bet on economic activity is via investing directly in industries such as consumer, healthcare, technology, banks, insurance, industrials, real estate, materials, energy and utilities.

Another way is to bet on the speculators of economic activity. This can often be a leading indicator of recovery in the underlying economy. For this reason, I am tracking the US Capital Markets sector closely:

IAI: Exposure to US Capital Markets Activity

The iShares U.S. Broker-Dealers & Securities Exchanges ETF (NYSEARCA:IAI) gives exposure to the US capital markets industry. This includes investment banks, brokerages and stock exchanges. Here’s what the composition looks like:

IAI ETF Composition

Sector Mix

IAI ETF Sector Exposure (IAI ETF Website, Author’s Analysis)

Investment banking and brokerages alone make up 77.4% of IAI’s overall exposure. Very little exposure is in the asset management companies. This suggests that IAI is geared more towards activity in the financial markets, rather than performance of financial market participants.

Top 5 Holdings

The top 5 companies on the IAI ETF are Charles Schwab Corp (SCHW), Goldman Sachs Group Inc (GS), Morgan Stanley (MS), MarketAxess Holdings Inc (MKTX), and Intercontinental Exchange Inc (ICE).

The top 5 holdings make up 55.5% of the overall index, suggesting some index concentration. The top 2 holdings, SCHW and GS contribute about 40.6% to the overall index. Within this top 2, there is a diverse mix of blend of exposure with SCHW being geared more towards retail capital markets activity and GS being more linked towards institutional capital markets activity.

Key Fundamental Drivers for IAI

Interest Rates

Interest income is boosted with the money in brokers’ platform when interest rates are higher. This is a strong tailwind for IAI. The US Fed’s more hawkish stance in December 2022 indicates more rate hikes ahead. The US 10-yr yields are also in a state of hawkish inertia:

US10Yr Yield (TradingView, Author’s Analysis)

Appetite for M&A, capital raises and IPOs tends to be greatest during periods of economic expansion and lowest during times of economic contraction. Thus, the consensus expectations of a recession will probably weigh down on IAI.

Financial Markets Volatility

In a previous deep dive on Interactive Brokers (IBKR), I noted how Interactive Brokers’ clients’ trading frequency is positively correlated with market volatility. I note the key data point here again as it is central to this driver:

Interactive Brokers Trade Frequency vs VIX (Interactive Brokers, Yahoo Finance, Author’s Analysis)

Although this analysis shows the connection between Interactive Brokers’ trade frequency statistics vs the VIX, I believe the same logic applies to other brokers as well. This is because I have no reason to believe that the underlying behavior of the investor and trader is not platform independent.

Currently, the VIX (VIX) is at 21.66, which is within the long term average range from 15.78 to 22.78. This indicates a normal volatility environment:

Hence, compared to a few months ago, my previous bullish view on IAI has moderated. Given those key fundamental drivers, let’s look at the technical analysis situation:

If this is your first time reading a Hunting Alpha article using Technical Analysis, you may want to read this post, which explains how and why I read the charts the way I do, utilizing principles of Flow, Location and Trap.

Read of Relative Money Flow

IAI vs SPX500 Technical Analysis (TradingView, Author’s Analysis)

An upward movement on the relative chart of IAI/SPX500 means IAI is outperforming the S&P 500 (SPY). Conversely, a downward movement means the IAI is underperforming the S&P 500.

IAI/SPX500 has had a healthy move up and is now reacting off monthly resistance. The incumbent flow and trend are upward, and I anticipate the continuation of the flow. But I believe it is now due for a pull back towards monthly support before the move up resumes.

Read of Absolute Money Flow

IAI Technical Analysis (TradingView, Author’s Analysis)

On a standalone basis, I believe IAI will remain rangebound as it reacts from the $102.99 monthly resistance and the $79.98 monthly support. No clear highs or lows have been broken, which is why I anticipate a bit of a neutral stance for now until any bullish moves resume.

Summary

In my view, the higher interest rates do give a tailwind to IAI. However, the technicals currently suggest that a momentary pullback is due before the uptrend resumes. The continuation of the uptrend and IAI’s relative outperformance over S&P 500 may correspond with higher VIX levels and hence higher trade frequencies in 2023.