QQQE - Using QQQE To Add Equal Weight To Your QQQ Portfolio

2023-12-20 21:44:12 ET

Summary

• Most of the rally in the Invesco QQQ Trust ETF has been driven by seven big tech stocks, including Apple, Microsoft, Alphabet, Nvidia, Amazon, Meta Platforms, and Tesla.
• The concentration of these stocks in the ETF has decreased due to a rebalancing act, but it is still high considering potential market conditions in 2024.
• Investing in the Direxion NASDAQ-100 Equal Weighted Index Shares ETF may be a better option, as it trades at a discount and allows for broader exposure to tech stocks.
• It has also outperformed its Invesco peer when looking at short-term historical performance.

The rally enjoyed by the Invesco QQQ Trust ETF ( QQQ ) has been driven mostly by seven big tech stocks namely Apple (NASDAQ: AAPL ) Microsoft (NASDAQ: MSFT ), Alphabet (NASDAQ: GOOG ), Nvidia (NASDAQ: NVDA ) Amazon (NASDAQ: AMZN ) and Meta Platforms (NASDAQ: META ) and Tesla (NASDAQ: TSLA ). These have also been called the group of Magnificent 7 (Mag 7).

Now, for those who have stayed long cash and missed the rally and are now engulfed by the feeling of missing out or FOMO, this thesis aims to show that the most appropriate way of investing in tech at this particular juncture may be through the Direxion NASDAQ-100 Equal Weighted Index Shares ETF ( QQQE ).

For this purpose and bearing in mind that the equal weight strategy has failed to deliver throughout most of this year, I will support this thesis using a comparison of QQQE's price performance with QQQ while showing that market conditions in 2024 will not necessarily be a continuation of this year.

I start by elaborating on concentration risks.

Concentration Risks in QQQ

The last time I covered QQQ back in March 2023, Mag 7 constituted around 49.53% of the ETF’s total weight which was huge in terms of concentration risks, especially for those who are risk-averse. Since then the percentage has fallen to 42.89% which signifies a reduction of 6.64%. Now, since the tech-heavy QQQ has appreciated by over 39% since March and the Nasdaq-100 Index tracked by the ETF tracks is market cap weighted, you would have expected the weight Mag 7 to have increased, not decreased. This discrepancy is explained by a special rebalance that was effected on July 24 by the fund manager or Invesco to address the overconcentration problem. This involved a 0.5% to 3% reduction in the Mag 7 stocks. Thus, from 55% before July 24, the rebalancing act subsequently reduced the weight of Mag 7 to around 43%.

The rebalance conversely increased the relative weights of other stocks in QQQ’s portfolio but 43% dedicated to Mag 7, as per the list of ten top holdings below is still high considering that market conditions in 2024 are likely to be different than in 2023.

First, while more investors are expecting rate cuts next year, which should be favorable to equities in general, inflation remains well above the Fed’s 2% target and one should therefore also accept the possibility of borrowing costs staying higher for longer. This would be the exact opposite of a loosening of monetary policy conditions which is driving the broader markets to new highs currently.

Second, these big tech are also multinationals that export both goods and services to the rest of the world and as such have been helped by the weakening dollar in 2023. The U.S. dollar index mostly varied within the $100 to $105 range , well below its September 2022 high of $114. However, the favorable foreign exchange conditions could change with the higher for longer rates narrative.

Third, while there is a higher probability for a soft-landing scenario for the U.S. economy whereby a recession is avoided, GDP growth is expected also slow considerably relative to this year, which means that the favorable macros that have supported the market may simply be absent in 2024.

The Appeal of QQQE

In these conditions putting more money in QQQ is not advisable especially given that the ETF trades at a P/E of 23.54x which is 3.7% higher than in March this year and this despite the rebalancing. Instead, you could wait for Invesco to perform another rebalance, but, thinking aloud, a more astute way of investing would be through QQQE which trades at 20.81x or an 11.6% discount about QQQ.

Now, based on this 11.6% discount, I have a target of $93.56 (83.84 x 1.116) based on the share price of $83.84 at the time of writing.

This bullish position is further supported by a broader price action whereby smaller stocks in relative terms are now participating in the tech rally, and to a higher degree than seen earlier. This is evidenced by the chart below which shows the differential between the performances of QQQE and QQQ (or QQQE minus QQQ) for different periods spanning from one month to three years.

In this case, after initially being negative and in favor of QQQ, the difference in performance has recently turned positive for one month at 2.47%, this time in favor of QQQE. This shows that investors are reducing their preference for the Mag 7, and instead preferring to put their money in a broader range of tech stocks. In other words, the comparison of the price actions of QQQ and QQQE depicts a gradual rotation out of the Mag 7 in favor of a broader basket of tech and is also emphasized by Seeking Alpha analyst Steven Cress in a recent thesis .

Therefore, in case you already own QQQ shares and remain undecided as to how to play it out for 2024, QQQE may be the answer unless you are prepared to wait for a technical retrenchment to buy the dip and do dollar cost averaging. In a way, the equal-weighted fund enables you to continue participating in the ability of tech stocks to benefit from the billions of dollars of potential productivity gains enabled by artificial intelligence, but, in a way that involves less concentration risks. For this matter, as shown in the diagram below, QQQE also holds Mag 7 stock, but at a weight confined to 1% as pictured below.

Interestingly, the 0.35% charged by QQQE is only 0.15% above what is charged by Invesco. As such, an equal-weight fund entails a more active management approach than a market-cap-weighted one as the fund managers have to work harder to adjust the portfolio. For example, when the weight of one or several holdings has gone beyond 1%, they need to sell some of the shares to use the proceeds to purchase shares of the other companies. This needs to be done constantly and is carried out during the quarterly rebalancing which maintains the consistency of equal weightings after the usual market fluctuations. As such, QQQE also provides a more balanced exposure across sectors.

Furthermore, QQQE charges less than the First Trust NASDAQ-100 Equal Weighted Index Fund ( QQEW ) whose expense ratio is 0.58%, and also pays a higher dividend yield of 1.11%. Therefore, the Direxion ETF certainly has an appeal, but, on a cautionary tone, this will also depend on its one-month outperformance of the mighty QQQ being sustained.

Putting Things and Perspective and Need to be Diversified

In this respect, this bullish thesis for QQQE is based on Mag 7 stocks being expensive compared to their historical valuations. Thus, after posting more than 200% one-year returns, Nvidia trades at a forward P/E of 25x , and Apple is at nearly 30x after a 45% upside. Microsoft, Amazon, and Tesla sit at 33x, 40x, and 69 times the next 12-month earnings, respectively.

By comparison, the P/E for the S&P 500 sits at roughly 22 times. Still, this is lower than in 2021 when the broader market index peaked at 39x , or during the dot-com bubble, when it was at 47 times earnings. Therefore, when putting things into perspective, it is found that the S&P 500 is trading lower than its previous records which in turn makes it easier to digest the higher valuations of Mag 7 stocks.

Also, these are all profitable companies, are growing revenues, and are cash-rich as charted below. This means that in case economic conditions worsen or when there are abrupt market fluctuations as was the case during the March banking turmoil, they are likely to resume their roles as bastion of safety stocks.

In conclusion, this thesis has made the case for investing in QQQE based on a comparison with QQQ. Also, sometimes when a portfolio has worked well, it is easy to forget that investing is trying to be as diversified as possible, which goes against the practice of being confined to a just few big names and facing concentration risks. Noteworthily, each year has its particularities with 2024 expected to be the year when the Fed cut rates three times, but we all know that it is absolutely difficult to predict with certainty what will happen. The reason is because of the lag between monetary policy action and its economic effect which can take as long as 29 months to show up.

In these circumstances, it is better to be as diversified as possible and here, one of QQQE's advantages is that it allows investors to hold on to the big names that have outshone all the rest, while at the same time participating in the broader market action.

For further details see: