If Cloud Computing Stocks Get a Second Wind, This ETF Is Primed to Float Higher

Fans of stocks devoted to the cloud computing industry have had a rough go of it recently. But now, cloud computing stocks and exchange-traded funds (ETFs) that track them, like the GX Cloud Computing ETF (CLOU) are looking up. Is there a second wave of rising stock prices underway? Let’s take a look. 

This seven-year-old ETF is comprised of about 40 stocks, but only 10 of them account for nearly half the assets. One thing I like about this ETF is that it is more of a cloud computing pure-play. You won’t see any Magnificent 7 stocks on that list above. 

This ETF has actually declined in price over the past five years. That should tell us all we need to know about how it has failed to keep pace with the other side of the artificial intelligence (AI) trade. The hyperscalers and semiconductor companies have eaten into cloud stocks’ business. 

However, there’s a strong case to be made that they are not going to meet those lofty market expectations. It follows that CLOU might have been pushed down too far in price. Cue the buying opportunity?

After the pandemic, valuations in this market area contracted. Enterprise businesses tightened their budgets, which was a direct hit to cloud computing infrastructure and software-as-a-service (SaaS) providers. That is now stabilizing. 

The driver behind the recent price action in CLOU is infrastructure demand generated by enterprise AI projects. Rather than replacing cloud computing, AI deployment requires a huge amount of cloud-hosted compute capacity, storage, and data management layers.

The first era of cloud growth focused on basic migration: moving legacy on-premises databases to remote servers. The current phase is driven by data density. Generative AI models and enterprise automation platforms require continuous access to high-performance computing clusters hosted on public and hybrid clouds.

CLOU’s portfolio captures the entire cloud ecosystem, including SaaS, platform-as-a-service (PaaS), and infrastructure-as-a-service (IaaS). As corporations shift AI experiments into full production, monthly recurring revenue for cloud infrastructure providers, data warehouse platforms, and observability software expands.

What Are the Key Risks of Investing in the CLOU ETF?

It starts with the high multiples we see above. Trailing earnings of 22x would not be so awful but for the fact that investors are reining in the valuation levels at which they consider these stocks to be fairly valued. The days of paying 30x–40x earnings for cloud computing stocks are gone. 

There’s also the spectre of the hyperscalers. Major cloud providers, like Amazon (AMZN) AWS, Microsoft (MSFT) Azure, and Alphabet's (GOOG) (GOOGL) Google Cloud, continue to capture a large share of infrastructure spending, putting margin pressure on smaller pure-play SaaS providers that dot the top-10 holdings of CLOU’s stock basket.

That’s the concerning narrative, but as they say in investing, it should never be comfortable. And to me, as a dedicated chartist, I understand the risks. But the upside potential is emerging. 

Sure, that first big move off the lows is past us. That’s what the daily chart shows me above. But look below at the weekly trend.

That’s a breakout, with fleeting but powerful potential upside. Perhaps 15% to 20% from here. Since my strong view is that nothing in the stock market is a buy-and-hold at this point, this trade can work if the broader market does not roll over. 

Put another way, CLOU can be an “anti-AI-success” trade for small portions of time. But to get a big, sustained move, it will need to be part of a rising tide.

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.