2024-01-19 09:45:50 ET
Summary
- The ProShares UltraPro QQQ ETF offers tech bulls a way to generate leveraged returns from the Nasdaq 100, but it can also be used as a vehicle to short.
- Shorting the TQQQ can be profitable during bear markets and even sideways markets due to the impact of beta slippage, but it comes with high volatility and risks.
- A short position on the TQQQ could be a good strategy in 2024 as US equity markets show signs of topping out and the Nasdaq 100 looks vulnerable.
The ProShares UltraPro QQQ ETF ( TQQQ ) seeks daily investment results that correspond to three times the daily performance of the Nasdaq 100 Index. The ETF is typically used by bullish short-term investors to generate higher returns than simply owning the underlying market. It also offers an opportunity for bearish investors to gain exposure to a Nasdaq 100 decline by shorting. As we have seen over the past two years, shorting the TQQQ can result in strong gains during bear markets and even prove profitable during sideways markets. With US equity markets showing signs of topping out, a short position on the TQQQ could work out very well in 2024. This strategy is highly risky, though, even from a short-term perspective, due to its high volatility. Over an extended period, these risks are heightened as returns can dramatically differ from those expected based on the performance of the underlying, and even a small rally can leave short investors with an increasingly large nominal position.
Losses Have Been Felt Harder Than Gains
Due to the mechanics of leveraged ETFs, their performance over extended periods can differ greatly from what one might expect based on the performance of the underlying. For example, from March 2020 to November 2021, the Nasdaq 100 rallied 140%, while the TQQQ rose by almost 900%.
TQQQ ETF Vs Nasdaq 100 (Bloomberg)
In contrast, since the November 2021 peak, the Nasdaq 100 is up by 3%, while the TQQQ is actually down by 45%. The reason for the underperformance of TQQQ over the past two years or so is due to outsized losses during Nasdaq 100 declines. For instance, from the November 2021 peak to the December 2022 trough, the TQQQ lost 82%, compared to 35% for the Nasdaq 100.
Why Not Just Long The SQQQ?
The ProShares UltraPro Short QQQ ETF ( SQQQ ) essentially does the opposite of TQQQ, providing holders with a 3x leveraged position on the inverse of the Nasdaq 100 on a daily basis. Unlike shorting the TQQQ, a long position in SQQQ means that losses are limited to the initial investment, which many investors may find preferable. However, when held over extended periods of up and down markets, the SQQQ suffers from the exact same thing that a short position in the TQQQ benefits from, which is beta slippage. This article does a good job of explaining the mechanics of this, while the chart below shows it in action. Over the past 3 years, while the Nasdaq 100 has risen by 28%, the TQQQ has been up just marginally and the SQQQ has fallen over 80%. Shorting the TQQQ would therefore have proved a much better bet than buying the SQQQ.
SQQQ and TQQQ. Bottom Panel Shows Impact Of Beta Slippage (Bloomberg)
A Short On TQQQ Makes Sense As Nasdaq Looks Toppy
A short position in the TQQQ should therefore pay off in 2024 unless the Nasdaq 100 moves higher in a stable fashion, which seems unlikely for two main reasons. Firstly, valuations are extreme, with the forward PE ratio at 30x, which is in the 93rd percentile of valuations going back two decades. This multiple is on par with that seen at the market peak of 2007, but back then, total Nasdaq 100 earnings were just $80bn compared to $615bn today. Nasdaq 100 earnings are now one-third of the S&P500 compared to less than 10% in 2007. The sheer size of the Nasdaq 100, with a market cap of $20trn, will make significant gains difficult to achieve without a significant improvement in economic prospects.
Nasdaq 100, Equally Weighted Nasdaq ETF, and Non Profitable Tech Index (Bloomberg)
Secondly, we have started to see risk appetite fray at the edges since the start of the new year. The markets that outperformed during the October-December rally have begun to decline, with non-profitable tech stocks coming under intense pressure, which could be a canary in the coalmine for the Nasdaq 100. The market is once again being supported by a tiny number of mega-cap stocks, with the Magnificent 7 market cap now 55% of the Nasdaq 100. Such extreme concentration combined with expensive valuations makes a large decline much more likely than a large rally, and therefore bodes well for a short position in TQQQ.
Not For The Faint Hearted
A short position in the TQQQ is certainly not a position I would recommend for risk-averse investors, even if they are highly confident of a Nasdaq 100 decline. The main reason is that even a small uptrend in the Nasdaq 100 can result in huge losses and a dramatic increase in the value of the position. A $10,000 short position on the TQQQ at the October lows would have led to a $6,000 loss and resulted in a position of $16,000 currently. Investors who wished to keep their short position at $10,000 would therefore have to buy back some of their positions on the way up, which goes against the idea of buying low and selling high.
For further details see:
TQQQ: A Short Opportunity For The Risk-Seeking Bearish Investor