IYY - Nasdaq 100 (And QQQ) May Be Heading To A New Low

2023-03-09 13:02:10 ET

Summary

• Jay Powell's Congressional testimony has shocked rates higher.
• This has led to real yields rising, and a decline in the TIP ETF.
• The Nasdaq tends to follow the TIP ETF very closely.

The Nasdaq 100 ETF ( QQQ ) could be on the verge of a significant decline in the coming weeks, potentially reaching new lows. This is likely due to a sharp increase in real yields, which have risen considerably following a string of better-than-expected economic data and Jay Powell's hawkish Congressional testimony.

The most significant changes since the testimony have been in nominal and real rates, with the 5- and 10-year inflation-protected TIP real yields surging back to levels close to their September and October highs. This is a critical development because, with the Nasdaq 100 ( NDX ) rising at the start of 2023, the spread between its earnings yield and real yields is now the narrowest it has been in over a decade, suggesting that the Nasdaq 100 is overvalued vs. bonds.

The TIP and QQQ Relationship Is Strong

Moreover, the iShares TIPS Bond ETF ( TIP ), which tracks real yields, is approaching last fall's lows. The TIP ETF tracks real yields, and when the TIP ETF rises, it indicates real rates are falling, and when the TIP ETF falls, it means real yields are rising. This is important because the QQQ ETF, which tracks the Nasdaq 100, has closely followed the TIP ETF in recent years. If the TIP ETF reaches its September and October lows, the QQQ will likely follow suit.

The TIP ETF and QQQ have closely tracked each other since the end of 2018. The gap between the QQQ and TIP has recently widened, indicating that the Nasdaq 100 has become increasingly expensive relative to real yields.

Additionally, looking more closely, it appears that the TIP ETF leads the QQQ by around 12 days. When shifting the TIP ETF 12 days forward versus the QQQ, it becomes clear that the effects of the recent decline in the TIP ETF (rising in real yields) haven't been fully felt by the QQQ.

Nasdaq is Very Expensive

This gap between the QQQ and the TIP can be visualized by looking at the spread between the Nasdaq 100 current earnings yield and the 5-year and 10-year TIP rates. Both of these are at their lowest levels in more than 10 years. This would suggest that investors are paying a lot to own the QQQ and the Nasdaq 100 vs. bonds for a long time.

This creates a real risk for the Nasdaq 100 because not only is it expensive vs. real rates, but it also means that valuations are likely to revert at some point, so real yields don't even need to rise further for the Nasdaq to fall.

What makes matters worse is that the 5-year and 10-year real yields one year forwards are pricing in pretty stable rates for both bonds. The 5-Year TIP one-year forward rate is 1.73%, versus the current rate of 1.81%. In comparison, the 10-Yr TIP one-year forward rate is 1.6% versus a current rate of 1.62%, which currently suggests at least as of now, the real yields aren't likely to fall materially to help make the Nasdaq 100 cheaper vs. bonds.

The TIP Is Breaking Down

The odds for the TIP to make a new low seems high based on an analysis of the technical chart. The TIP ETF is sitting right on a critical support level at $106.25, and if that level of technical support breaks, there isn't much to stop the TIP ETF from dropping back to the lows around $104.75. Additionally, the relative strength index for the TIP ETF shows bearish momentum, suggesting lower prices ahead for the TIP.

The TIP ETF may be one of the easier ways to gauge the direction of the Nasdaq 100, QQQ, and equity market. If the TIP heads to its prior lows and makes a new low, the Nasdaq 100 and the QQQ aren't likely to be far behind.

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