QQQ: Almost Time For A Breather

seekingalpha06-12

Invesco QQQ Trust ETF has started to outperform the broader market again, similar to last summer.The top stocks within QQQ are not excessively overvalued, as earnings growth has kept up with price ...

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The NASDAQ 100 index was rebalanced on July 24, 2023 specifically because of this high concentration. According to Morningstar, the concentration of the top 7 companies went from 54.6% before the reweighting to 46.0% after. Morningstar The ETF's dependence on the few largest companies for its recent outperformance is reminiscent of summer 2023, and it's possible that the time for a pullback is again approaching. Unlike last year at this time, however, I am not yet recommending selling the index or buying puts. Valuations of the top stocks are no higher than they were last year, and some have even gotten less expensive. Also, both technical and seasonal factors suggest waiting at least a month before getting defensive. Valuations Are Similar Except For Amazon and Nvidia, Which Are Less Expensive Last year, I noted that the forward P/E of the 4 of the top 6 companies ranged from 23.6 to 34.8. Amazon  and NVIDIA  were much more expensive than this. 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I rated the ETF a Sell and bought put options expiring about 6 weeks out. That turned out to be a bad trade, as QQQ hit a short-term peak in July right around that expiry date. The Sell rating was not a disaster, however, as long as sellers covered by the end of October. Seeking Alpha From that point until late April, QQQ continued its uptrend, but its outperformance compared to the broader market (SP500) (SPY) was more muted. Even the equal-weight versions of these indices (QQQE) (RSP) performed well, indicating a more broad-based rally depending on more than just the Mag 7. Over the last 6 weeks, however, the market cap weighted indices, especially QQQ continued to charge ahead while the equal-weighted averages went nowhere. Seeking Alpha The ratio of the cap-weighted to equal-weighted index (QQQ/QQQE) has also gone on to hit new record highs. Data by YCharts A year ago, the Magnificent 7 companies, or the top 8 stocks in QQQ considering Alphabet consists of both (GOOG) and (GOOGL), made up 54.8% of the ETF. Now, the percentage is 44.5% and Broadcom (AVGO) has replaced Tesla (TSLA) in the top 8 stocks. Is this a sign that the smaller companies are doing better? Unfortunately, no. The NASDAQ 100 index was rebalanced on July 24, 2023 specifically because of this high concentration. According to Morningstar, the concentration of the top 7 companies went from 54.6% before the reweighting to 46.0% after. Morningstar The ETF's dependence on the few largest companies for its recent outperformance is reminiscent of summer 2023, and it's possible that the time for a pullback is again approaching. Unlike last year at this time, however, I am not yet recommending selling the index or buying puts. Valuations of the top stocks are no higher than they were last year, and some have even gotten less expensive. Also, both technical and seasonal factors suggest waiting at least a month before getting defensive. Valuations Are Similar Except For Amazon and Nvidia, Which Are Less Expensive Last year, I noted that the forward P/E of the 4 of the top 6 companies ranged from 23.6 to 34.8. Amazon (AMZN) and NVIDIA (NVDA) were much more expensive than this. Since then, earnings increases have kept up with share price increases for Apple (AAPL), Microsoft (MSFT), Google, and Meta (META). Their forward P/E ratios are little changed. Where we do see a big change is in the P/Es of AMZN and NVDA, which have come down into the 40s compared to the 80 and 50 level they were trading at last year. It turns out that the high P/Es last year were justified based on the high earnings growth rates of these two stocks. Data by YCharts If we invert the P/E and look at the earnings yield, the 4 cheapest mega-caps now have earnings yields of 2.7% - 4.2%, compared to the 10-year Treasury yield (US10Y) of 4.4%. The Mag 7 now has a negative earnings yield spread compared to the 10-year, unlike last year when they were closer to even. When the bull market began at the start of 2022, these stocks had earnings yields of 2.9% - 3.3%, a positive yield spread compared to the 10-year yield of 1.6%. As we get closer to a rate cutting cycle, I am not as worried about this declining earnings yield spread as I would be when rates are increasing. The lower spread could just be signaling an anticipated decline in interest rates rather than an overvaluation of the stocks. Technicals: Watch RSI, But Don't Act Yet During the bear market of 2022, the RSI (Relative Strength Index) provided a good sell signal when it got near the overbought zone of 70. We saw this in March and August 2022, and even for the first pullback of the new bull market in February 2023. Since then, the RSI needed to spend more time in the overbought zone before the stock pulled back. As we saw in June and July 2023 as well as December 2023-January 2024, the RSI had to spike above 70 a couple times before a sellable pullback started. Looking at the current situation, the RSI is approaching 70 but has not yet spiked above it. I would look for two peaks above 70 before making any short-term QQQ sell trades or put option purchases. Seeking Alpha Seasonality: The High Is Probably In July Ignoring seasonality was probably my biggest mistake when I sold QQQ puts in June last year. July is historically the best month for QQQ, with zero instances of negative monthly returns in the past 10 years. September is the worst month, with 8 out of 10 years in the red. August has also been below average, especially the last two years. Seeking Alpha The seasonality cautions strongly against selling QQQ in June. If it is making new highs in late July accompanied by the RSI staying overbought for an extended period, I would be much more comfortable that a pullback is starting. Conclusion The Invesco QQQ Trust ETF is once again pulling away from the broader market, as it did one year ago. This outperformance can't go on forever, and a pullback eventually happens, along with periods of performance more in line with the rest of the market.  Traders and investors looking to take profits may not want to act yet, however. The valuations of the top stocks in the ETF are not out of line with last year, and the most overvalued ones last year, AMZN and NVDA, have even gotten less expensive. Technical indicators like the RSI as well as seasonality also suggest at least one more month of strong performance from QQQ. After that, the chance of a pullback is greater, possibly ending around the time of the November elections. As a value investor underweight the QQQ and its components, I am not shorting or hedging at this point, but I am also waiting for the expected late summer / early fall pullback before getting long.","kind":null,"is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"0","news_tag":"","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.29.1","shortVersion":"4.29.1","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2442322341"}