1 Smart Way to Play the Fading Data Center Trade

The iShares U.S. Digital Infrastructure and Real Estate ETF (IDGT) is one of those exchange-traded funds (ETFs) that I’ve come to appreciate as being a neat, niche fund. That’s a structural comment only. Because at this point in the market cycle, one which has seen IDGT play the role of major beneficiary of the “all in/we need compute power” trade, the chart looks like money is rushing for the exits. 

More on that below, after I acquaint, or re-acquaint, you with this ETF, which is REIT-like in some of its top holdings. But not the type that pays much yield. 

IDGT really tracks the health of the physical backbone supporting the artificial intelligence (AI) boom. And it does so very well. For the past two years, IDGT has been a major beneficiary of the massive capital expenditure (capex) surge. 

The narrative driving it was seemingly ironclad. No matter which software or language model ultimately wins the AI race, the world will require an infinite supply of physical data centers, fiber-optic networks, and telecom towers to route and store the data.

But following a series of stark reality checks across the tech space, especially IBM's (IBM) warning about corporate budget cannibalization and Broadcom's (AVGO) cautious guidance, the types of stocks IDGT represents, the physical infrastructure trade, look spent. 

A Closer Look at IDGT

The purple lines I drew in that daily price chart above point to two related issues. Up top, the ETF shows signs of “distribution,” which is a fancy way of saying “big money wants out, but can’t get out in one shot, so they keep dripping stock out to sell, gradually.” The moving averages reflect that.

The lower part of the chart, the PPO, had every excuse to take a pause, then rally. But as I circled, it didn’t fire. That now looks more as if the dip will be followed by more dips. Lower lows and lower highs. Not good for IDGT bulls. 

This $490 million ETF is part REIT, part telecom. But the REIT side is data center and cell tower REITs, the type that are really more like tech stocks with a REIT structure. They have been darlings for a while, but it's getting late to the party. At 19x trailing earnings, IDGT is not too cheap. And the dividend yield is a very thin 0.8%. Like I said, REITs included, but not the kind income investors flock to.

The top 16 stocks, half the total in this ETF, are listed below. The top 10 stocks comprise nearly 65% of IDGT, and the 16 presented here get that figure well over 80%. 

To understand why IDGT is such a pure barometer for the shift alluded to above, we have to look at how the ETF is built. It doesn't hold speculative software companies. It invests in the actual brick-and-mortar layer of the internet, dividing its assets across three heavy-infrastructure buckets. The aforementioned data center REITs and cell tower giants, as well as connectivity hardware stocks. These are the specialized networking and storage equipment providers that physically wire these facilities together.

When corporate America was frantically hoarding server space and racing to build out infrastructure, IDGT was a fine safe haven for institutional investors. But that front-loaded buying frenzy appears to be fading fast.

How to Play It

For those looking to hedge here, there’s not much liquidity in IDGT ETFs. And there’s no direct inverse ETF. However, this is where DIY investors can get crafty. 

Think of it like this: the market is so correlated now. Especially the risk-on/risk-off nature of anything AI-related, like IDGT. So to hedge it indirectly, the usual suspects such as the Short QQQ -1X ETF (PSQ) can likely accomplish the goal. 

The additional kicker would be if IDGT outperforms the Nasdaq-100 Index ($IUXX). If that happens and you own IDGT and PSQ, that is a bit of arbitrage that works in your favor. In a market like this, the more tools you learn how to use, the better.

Rob Isbitts is a semi-retired CIO, former fiduciary investment advisor, and Barchart columnist. Check out his other work at ETFYourself.com (featuring the Fresh Charts weekly trading post) and ROAR.PiTrade.com, helping investors to better manage their own portfolios.