2024-01-19 15:14:34 ET
Summary
- I project a bullish outlook for JEPQ in 2024, due to improving macro setting and supportive AI adoption.
- Anticipated rate cuts and a weaker dollar are expected to benefit growth assets like Nasdaq 100 and JEPQ constituents.
- JEPQ's call overwrite strategy provides income generation and downside protection in high-risk environments.
As we head into 2024, my outlook on JPMorgan Nasdaq Equity Premium Income ETF ( JEPQ ) is becoming more positive once again. In mid-2023 , I had given it a "Hold" rating, but now I'm feeling more optimistic, as I see some promising signs of growth for Nasdaq 100 assets, supported by a backdrop of a better overall economic situation and increased use of artificial intelligence. In that context, I do anticipate that there will be some equity volatility due to speculations about potential interest rate cuts. Interestingly, this volatility could actually be beneficial for JEPQ because the fund employs a call overwrite strategy that thrives on market fluctuations and may thus offset also some concerns about valuation sentiment.
Macro Setting Up For A Bullish Backdrop
I am bullish on growth assets such as Nasdaq 100 (QQQ)/JEPQ constituents, as the 2024 economic outlook is shaping up with an expectation of significantly declining interest rates, driven by a downturn in inflation and efforts to stabilize economic growth. Relating to lower rates, I see multiple tailwinds that merit attention: Firstly, I point out the benefits of lower discount rates on earnings, which makes the present value of future earnings more valuable; Secondly, I highlight the reduced borrowing costs which ease access to debt-fuelled investments and expansion; And thirdly, I argue that lower rates will decrease the relative attractiveness of fixed income securities, potentially prompting an asset rotation in favor of (growth) equities.
My confidence in a favorable rate environment for 2024 is supported by the Federal Open Market Committee's December 13, 2023, projections : The FOMC now anticipates around 75 basis points in rate cuts for 2024, a significant shift towards dovish policy compared to the 25 basis points projected in September. Interestingly, market traders seem to be ahead of the Federal Reserve in anticipating these rate cuts. Many are predicting that the Fed might start reducing rates as early as March, with the CME FedWatch Tool showing a 75% probability of a 25 basis point cut. By the end of 2024, the market is factoring in a total reduction of up to 150 basis points, pointing to an expected rate near 3.5%.
On an additional macro note, I am also optimistic about the outlook of a weaker dollar and related beneficial consequences for US stocks. Not only does a weaker dollar drive stock investments, as buying U.S. stocks becomes cheaper for foreigners, but also drives EPS for big tech companies. Notably, all major tech companies listed on the Nasdaq 100, and included in JEPQ, generate a significant and growing share of revenues overseas. When the dollar weakens, it makes US products and services more affordable in foreign markets, potentially boosting sales and profits for these companies.
Lastly, I point out the commercial tailwind for big Tech stocks coming from a resilient and strengthening consumer base. In that context, investors should consider that a large share of Big Tech earnings is based on direct-to-consumer business models, like advertising for Meta (META), Google (GOOG) (GOOGL), Microsoft (MSFT) (through Bing), and Amazon (AMZN) (Prime and shopping feed placement). In addition, companies like Apple (AAPL) and Microsoft also depend heavily on discretionary spending, from software to electronics.
AI Set To Drive The 2024 Growth Narrative
Having established the attractiveness of growth assets in 2024, I am especially bullish on opportunities that have a strong exposure to AI, pointing to early, but rapidly expanding adoption of AI technologies. As AI becomes more integrated into various industries, companies that develop or utilize AI technologies could see increased demand for their products and services, potentially boosting their stock prices. Supporting this thesis, I highlight a recent survey conducted by Morgan Stanley, which suggests that CIOs are preparing for increased IT spending in 2024. In that context, CIOs have pushed AI/ML to the forefront of their priorities, with 68% of respondents reporting that AI influences their current IT budget planning (Source: Morgan Stanley research note dated 11th January, 4Q23 CIO survey).
Discussing AI, the Nasdaq 100 constituents, and consequently, the JEPQ holdings , are exceptionally well-positioned to capture AI potential. In this context, I point out that the JEPQ portfolio holds concentrated positioned major tech firms, including Alphabet, Amazon, Microsoft, Meta Platforms, and Nvidia. According to data compiled by Seeking Alpha, analyst expectations for these companies project alpha-rich EPS growth in 2024:
- Microsoft: +14% YoY
- Apple: +7-8% YoY
- Alphabet: +16% YoY
- Amazon: +33% YoY
- Nvidia: +64% YoY
- Meta Platforms: +21% YoY
JEPQ To Ease Valuation And Volatility Concerns
Despite the strong tailwinds supporting the attractiveness of growth and tech assets, investors may be uncomfortable buying into a Nasdaq 100 benchmark due to valuation concerns.
After having returned about 45% for the trailing twelve months, compared to a gain of less than 19% for the S&P 500 (SP500), market participants may argue that there is little valuation upside left. Acknowledging this concern, I highlight that the JEPQ ETF, while offering exposure to Nasdaq 100 constituents, actually limits the upside in favor of recurring income and downside protection. This is achieved through a call overwrite strategy, involving an investor holding a long position in an asset while simultaneously selling call options on that same, or closely related, asset. In simpler words, the JEPQ approach aims to generate additional income from the option premiums.
Relating to the call overwrite strategy, there is an additional argument why the JEPQ may be preferable to an outright Nasdaq 100 position. Investors should consider that in a perceived high-risk environment, the premiums for call options are generally richer due to the increased volatility implied in options prices, making the call overwrite strategy more lucrative. The strategy also somewhat limits downside volatility, as the income from the option premiums can offset potential losses from the underlying asset.
Investor Takeaway
The macroeconomic landscape is favorable for growth assets like Nasdaq 100 and JEPQ constituents. This optimism is driven by expectations of lower interest rates, a projected weaker dollar, and a strong U.S. consumer base. Moreover, I view the gradual adoption and monetization of AI technologies as a key growth driver for Big Tech companies, most notably the Magnificent Seven, which is a core asset base of the JEPQ portfolio.
Despite the strong commercial momentum and outlook, high valuations of Nasdaq 100 companies, paired with uncertainty about the timing and magnitude of rate cuts, may make investors cautious about an outright Nasdaq 100 investment. To balance these concerns, I like JEPQ's approach to leverage a call overwrite strategy. This strategy is particularly effective in high-risk environments, leveraging higher option premiums due to increased volatility for income generation and downside protection.
In summary, I view the JEPQ ETF as a great vehicle to play the equities markets in 2024. Buy.
For further details see:
JEPQ: Why It's A Great ETF To Play The Stock Market In 2024