QQQ: Performance And Valuation Update – October 2019 – Seeking Alpha

The Invesco QQQ ETF (NASDAQ:QQQ) once again is trading within a few points of its all-time high with a really impressive performance in recent months, essentially tearing down the proverbial "wall of worry". The fund is up 25% year to date on a total return basis, driven by a combination of better-than-expected earnings from the leading stocks, along with more bullish overall sentiment supported by the recent Fed rate cuts. In September, a breakthrough in the U.S.-China trade dispute reaching what was called a "phase one agreement" potentially opened the door for more upside through the end of the year. On the other hand, lingering concerns over decelerating global growth and a more uncertain outlook for the U.S. economy may limit a clear breakout to the upside. This article looks at the recent performance and valuation metrics of QQQ, along with our view on where the fund is headed next.

(Source: Finviz)

What else is there to say about QQQ - the quintessential large-cap growth fund with technology sector stocks representing 44.5% of allocations? While traditionally recognized as a tech-based index, the actual sector breakdown from the NASDAQ 100 are largely arbitrary, as many stocks blur the lines between technology and other sectors like consumer discretionary and healthcare. From an industry perspective, software application represents 15.6% of the fund, and this is an area of the market that has been very strong considering the move by companies towards the "software-as-a-service" model and of utilization of cloud-based infrastructure that offers centralized and more resource efficient solutions. The theme is generally high segment leadership and product innovation.

(Source: Invesco)

QQQ is up 392% over the past decade, significantly outperforming a broad market index like the S&P 500 (SPY), highlighting the attraction of the fund as a long-term winner. It's hard to find any fund with a better historical return. Volatility has increased in recent years, but time and time again the leaders in the group have been able to prove skeptics wrong with continued strong growth.

Data by YCharts

The context of the big gains in QQQ and underlying stocks this year go back to the historically volatile period of Q4 2018 when the stocks briefly approached "bear market" territory, as QQQ fell by as much as 23% in late December. More dovish policing signaling by the Fed in the new year, along with better-than-expected earnings in conjunction with a resilient economic environment, has brought back many of these stocks to trade near their 52-week and, in some cases, their all-time high. In this regard, many of the impressive percentage gains are more based on a "rebound" from the depressed levels at which the stocks began the year.

Apple (AAPL), for example, traded down to $140 in January and has since climbed 69% from that low. Among the top 25 holdings, Netflix (NFLX) is the only stock with a negative return year to date, down 0.4% through October 22nd. The company has traded at an aggressive growth premium for many years, while more recent weaker-than-expected subscriber growth has pulled some of that enthusiasm. The stock is down about 31% from its 52-week high.

Top 25 QQQ Holdings Performance

Source: Data by YCharts / Table by author

Looking at our data set with from the full list of 103 current equity holdings, we highlight the following points to present a rounded picture of the underlying performance.

QQQ Holdings Performance Distribution

Source: Data by YCharts / Graph by author

YTD %TR

A group of chip stocks are among the biggest winners in QQQ this year. KLA Corp. is the best performer so far in 2019, up an impressive 85.5%. The company, which is a leader in process control systems for the industry, has presented revenue growth in the 20% range this year, coupled with double-digit EPS growth. The theme between Lam Research Corp., Advanced Micro Systems, ASML Holding, and Applied Materials has been industry leadership in their respective segments, with generally better-than-expected growth and earnings this year. Semiconductors as an industry has been weak this year given lower chip shipments and more tepid demand in Asia, but these companies are clearly outperforming the market. MercadoLibre, recognized as the leader in e-commerce in Latin America, is up 83% year to date, benefiting from growth in its payments solutions. The stock has been more volatile recently and down 23% from its high of the year.

The Kraft Heinz Co.

Among the 10 worst performing stocks in the fund this year, it's a mixed bag from an otherwise unrelated group that includes Chinese search giant Baidu down 35%, The Kraft Heinz Co. down 31%, Tesla down 23%, and American Airlines Group down 11.2%. Without sharing a common industry theme, the weakness here is generally company-specific, as evident from weaker-than-expected earnings this year. Biogen is still down by 6.3% year to date, but we note the stock has been rallying this month on an improved outlook and is up 21% just this October.

One of the bullish trends for QQQ is that for the underlying holdings, current valuations appear relatively reasonable at the fund level. Beyond a couple outliers like Amazon.com (AMZN) and Netflix with a P/E ratio at 73.3x and 85.2x each respectively, most stocks in the fund trade at much more down-to-earth earnings multiples. Fund manager Invesco notes that the weighted harmonic average P/E for QQQ is currently at 22.6x. While we can make the case that certain stocks within the fund may be cheap or expensive, simply looking at the numbers without any bias over the individual names would make a compelling case for QQQ as a worthy investment.

We note that 30 stocks, or one-third of the holdings and representing 50% of the total weight, have reported revenue growth above double digits in the last quarter. Another point we like is that the balance sheets on average of the underlying firms within QQQ are overall under-leveraged, with a number of high-profile companies like Facebook (FB) and Alphabet (GOOGL, GOOG) carrying no long-term debt. This isn't necessarily a reason to buy on its own, but is nevertheless is a strong point for QQQ as an ETF.

Top 25 QQQ Holdings Valuation

Source: Data by YCharts / Table by author

We think it's a delicate period in the market cycle considering signs of decelerating economic growth and a more uncertain outlook which has been acknowledged by the Fed in justifying recent rate cuts. Recent bullish sentiment driving QQQ to approach a new all-time high has been in part based on favorable developments in the U.S.-China trade dispute with an easing of tensions in recent months, along with expectations that the trend lower in interest rates will help extend economic growth. Our own opinion is to be more cautious recognizing the momentum lower in global economic indicators and potentially peaking U.S. consumer dynamics that will be hard to sustain. The 2020 Presidential election in the U.S. represents a number of risks given the uncertainty, and we expect volatility to remain elevated over the next year.

The setup here is simple. If you are bullish on the economy, bullish that the Fed will be successful in its attempt at reviving growth expectations, and bullish that the tech continues to lead, then QQQ likely has more upside. On the other hand, a more bearish view on global macro conditions likely represents significant downside potential for the fund given the high cyclical exposure of the core names. For the record, we see risks as tilted to the downside with a bearish macro outlook and a belief that the underlying holdings of QQQ will be challenged to exceed current growth expectations. Take a look at the fund's prospectus for a full list of risks and disclosures.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am long and short numerous stocks via options including underlying components of QQQ.

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QQQ: Performance And Valuation Update - October 2019 - Seeking Alpha