2023-10-08 07:39:41 ET
Summary
- The seasonal investing strategy on favoring JPMorgan Nasdaq Equity Premium Income Fund over the Nasdaq 100 ETF has played out so far.
- Bullish sentiment waned in September despite bullish seasonality on deck.
- I assert that taking profits on JEPQ and favoring QQQ is the way to be positioned looking out to early 2024.
I outlined a seasonal investing idea on the JPMorgan Nasdaq Equity Premium Income Fund (JEPQ) in early August. My thesis rested upon the usual pattern of declining stock prices in the often-volatile months of August and September, with an eventual early Q4 low in equities before a year-end rally. So far, that outlook has played out, and it's time for a refresh on the play.
The S&P 500's closing high for the year thus far came back on July 31 during the heart of the Q2 earnings season. With third-quarter profit results on the doorstep, sentiment on Wall Street is much different. Amid soaring interest rates, a surging US dollar, and volatile energy prices, anxiety is elevated between both stock and bond investors. Just last week, the AAII sentiment survey revealed an uptick in bears from a month earlier.
While I have concerns about the market's correction eventually hitting the generals, such as the Magnificent Seven, bullish seasonal tailwinds are becoming an increasing likelihood, particularly after the bullish reversal after last Friday's jobs report which featured a hot headline number but more sanguine average hourly earnings figures.
I am downgrading JEPQ from a buy to a hold, now favoring being long the Nasdaq 100 ETF (QQQ) outright through early January. For background, since I first outlined the idea, JEPQ has had solid momentum and has outperformed QQQ by about 1.5 percentage points. Not a home run, but losses were less and volatility was lighter with the income ETF.
JEPQ's August-September Alpha Compared to QQQ
Bullish Sentiment Wanes in September Despite Bullish Seasonality On Deck
According to the issuer , JEPQ generates income through a combination of selling options and investing in US large-cap growth stocks, seeking to deliver a monthly income stream from associated option premiums and stock dividends. The ETF aims to deliver a significant portion of the returns associated with the Nasdaq 100 Index with less volatility, and its construction includes using a long equity portfolio through a proprietary investment approach designed to drive portfolio allocations while maximizing risk-adjusted expected returns.
Part of why I am less inclined to want to be long JEPQ today relative to owning the Nasdaq 100 outright is the fact that implied volatility rose right up to noted resistance in the August review. The 24% level proved to be a barrier.
Could we see a sudden surge that lifts the Nasdaq 100 Volatility Index (VXN) toward its March peak near 30? Certainly, but the onus is shifting from being on the bulls to being put on the bears, particularly if interest rates settle down and decent earnings results are reported later this month. Be on the lookout for a possible uptick in volatility when mega-cap tech reports Q3 results during the week of October 22, but I'm inclined to think that a relief rally ensues thereafter.
Nasdaq 100 Volatility Index: Continued Resistance in the Mid-20s
Volatility Catalyst: Q3 Earnings in Late October
JEPQ has a high $5.7 billion in assets under management and sports a modest annual expense ratio of 0.35%. The trailing 12-month dividend yield is among the highest in the ETF universe for such a large fund at 11.8% as of October 6, 2023. JEPQ is a highly liquid fund considering that 90-day average volume is near two million shares and the 30-day median bid/ask spread is narrow at just two basis points.
The 91-holding portfolio generally matches the composition of the Nasdaq 100. The Information Technology sector is the largest weight at 49% with very low allocations to value sectors. In all, the top 10 positions make up a high 47% of the product's total assets.
JEPQ: Portfolio Breakdown & Dividend Information
JEPQ's Covered Call Overlay Strategy
Digging into the portfolio, JEPQ has high exposure to large-cap growth equities and has scant exposure to small or mid-caps. There is also a modest 8% allocation to large-cap value, which has been hit hard in the last several months care of high valuation in Consumer Staples and Utilities.
The fund's current price-to-earnings ratio has come down from near 27 in my original analysis to less than 23 today, suggesting the Nasdaq 100 is better valued now.
JEPQ: Portfolio and Factor Profiles
The early August article was premised on favoring the more defensive JEPQ over the more aggressive QQQ. I had a specific time horizon to early October, so it is a natural time to revisit the idea. Notice in the seasonal view below from Equity Clock that QQQ tends to rally about 5% from early/mid-October into year-end, with some further gains through the start of the new year.
Now that the often-volatile period from early August through early October is just about done, reversing the investment idea is the way to go, in my view. Also consider that an end-of-year chase for performance could lead to a continuation of what has worked in 2023 - mega-cap tech.
QQQ Seasonality: Strong Gains Mid-October to Mid-January
The Technical Take
Let's take a bit of a different approach to the technicals of this idea. Instead of reviewing the key price points on JEPQ, I analyzed the relative performance (total returns) of JEPQ to QQQ. Notice in the chart below that JEPQ did its job from early August through September. We are now seeing a rolling over of outperformance of the equity premium income fund.
I concede that this pullback could be comparable to the relative retreat seen in August, but I expect JEPQ versus QQQ to revisit the July nadir as Q4 rolls one. Is this reason to short JEPQ? I don't think so as it should still offer positive returns in such an environment.
JEPQ: Relative Strength Peaking After A Strong Q3 Advance
The Bottom Line
I suggest taking profits on the investment idea I outlined in early August (favoring JEPQ over QQQ). Given bullish equity seasonality, more favorable mega-cap valuations, downbeat sentiment, and upbeat earnings on tap, I expect QQQ to outperform JEPQ into early 2024.
For further details see:
QQQ Preferred Over JEPQ As A Bullish Q4 Gets Rolling