QQQJ - QQQJ: Expanding Market Breadth Can Kickstart A 2024 Rebound

2023-11-29 02:10:54 ET

Summary

• Invesco NASDAQ Next Gen 100 ETF invests in the largest 100 Nasdaq-listed stocks outside of the Nasdaq-100.
• The ETF's mid-cap exposure lagged the market in 2023 but appears well-positioned to lead higher going forward.
• QQQJ is a good option for investors to consider in this important market segment as a portfolio diversifier.

The Invesco NASDAQ Next Gen 100 ETF ( QQQJ ) invests in the 101st to the 200th largest companies listed on the NASDAQ exchange. By this measure, we look at QQQJ as the junior fund next to the more high-profile Invesco QQQ Trust ( QQQ ) with a distinct exposure more towards mid-caps.

A major theme in the market this year has been the outperformance of the mega-cap tech leaders, while smaller companies have been more pressured by the shifting macro backdrop including high-interest rates. Indeed, compared to a 37% return over the past year in QQQ, the Next Gen 100 ETF is up just 1%.

That being said, we believe QQQJ is well-positioned to climb higher going forward. In our view, an environment of easing inflationary pressures and stabilizing interest rates into 2024 should support expanding market breadth, benefiting this important market segment.

What is the QQQJ ETF?

QQQJ technically tracks the "The Nasdaq Next Generation 100 Index" which features a modified market capitalization-weighting methodology. In this case, a 4% weighting cap is applied to the relative market value of the 100 largest companies outside of the Nasdaq-100. There is also a quarterly rebalancing.

Notably, QQQJ excludes financial sector stocks as well as REITs. One explanation for this index-level decision considers that those groups are over-represented within Nasdaq and would otherwise dominate the fund at the expense of stocks in non-financial sectors driven more by company-specific factors other than interest rates and macro trends.

Going through the current portfolio , while Nasdaq is often synonymous with technology, the sector represents about 41% of the total exposure. This is followed by the Healthcare sector at 22%, and Consumer Cyclical names at 11% of the weighting.

CDW Corp. ( CDW ) and MongoDB ( MDB ) each with a 2.3% weighting are the two largest current holdings. Keep in mind that the Nasdaq and QQQJ also include international stocks, with China's Baidu ( BIDU ) with a 1.4% weighting as one example. On this point, non-US companies comprise approximately 12% of the fund.

QQQJ Performance

We mentioned that 2023 has been a challenging year for QQQJ, lagging behind broad market benchmarks, returning just 3.6% year-to-date. While the portfolio includes some big winners, there are also laggards dragging the performance.

Our data shows that just about half the stocks have a positive return this year which is indicative of the underlying volatility and uneven performance. MongoDB stands out as the top gainer with a 106% return thus far in 2023, while NovoCure Ltd. ( NVCR ) is the worst performer, losing -83% this year.

So to explain the performance spread between QQQJ and its big brother in QQQ, the latter benefited from a more concentrated portfolio among mega-cap leaders such as Apple ( AAPL ), Microsoft ( MSFT ), and NVIDIA ( NVDA ) that led the overall market higher within QQQ's uncapped capitalization based weighting methodology.

At the same time, it's worth placing the Next Gen 100 fund's return in the context of more comparable ETFs within its category. In this case, QQQJ's performance in 2023 is approximately in line with the 3% gain from the iShares Russell 2000 ETF ( IWM ) or the 6% return from the iShares Core S&P MidCap ETF ( IJH ).

The point here is to say that while QQQJ wasn't a world-beater in 2023, we're more interested in where it goes next.

What's Next For QQQJ?

Heading into 2024, there is a building consensus that the Fed is done hiking rates while the trend of lower inflation has even opened the door for rate cuts . This setup, even as the economy remains resilient and averts a recession, describes the allusive "soft landing" that may have appeared improbable going back to last year but is now moving closer to a reality.

The way we see it playing out is that this favorable macro backdrop should be positive for risk sentiment and set the stage for the next phase of the current bull market. So while QQQ and SPY have led higher, we believe the next leg higher will be defined by expanding market breadth where essentially a wider group of stocks participate in the rally.

In our view, QQQJ is well positioned to capture this trend, with its combination of cyclical names as well as emerging high-growth tech stocks that would deserve some expansion of valuation multiples. In other words, a rotation in the market away from the winners of 2023 and more toward beaten-down names including -mid and small-caps could be a powerful tailwind for QQQJ to gain momentum in 2024.

In terms of risk, the bearish case for this segment will likely need a deeper deterioration of economic conditions. If inflation somehow re-accelerated, this would force the Fed to potentially continue hiking, likely leading to a new round of financial market volatility. Ultimately, any development that impacts corporate earnings to the downside would represent a headwind for stocks.

Final Thoughts

What we like about QQQJ is that the fund offers a unique exposure to stocks that are not typically widely held or included in broad market indexes. This aspect adds to its diversification potential that can complement a core holding in a broad market fund like QQQ or SPY, for example.

In our view, QQQJ is a good option for investors to add equity exposure in an important market segment that can deliver positive returns over the long run.

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