The Nasdaq and the PowerShares QQQ Trust (QQQ) both hit multiyear highs on Monday — again — and on the surface, it’s the kind of technical event that inspires a whole new batch of buyers.
On the other hand, there’s no way to deny that the QQQ ETF has been oddly strong for too long, and is likely due for a dip sooner than later.
So what’s a trader supposed to do?
Before taking on any kind of position with the QQQ ETF, a smart trader must weigh all the pros and cons of stepping into such a trade right now. To help that thought process along, here are the biggest upsides and downsides everyone needs to mull regarding the PowerShares QQQ Trust.
The Current Upside of the QQQ ETF
The momentum of the QQQ ETF is undeniable — the fund is up 55% since November 2012 with no greater than a 7% stumble at any point since then. And nothing spurs bullishness like bullishness. The longer a move lasts, the more investors who felt like they missed out are willing to pour in, prolonging the strength.
Fear of missing out on more strength or lamenting the one that got away isn’t the only thing working in the market’s favor, however. The rhetoric regarding the market has also become increasingly bullish. Here’s one example, and another, and another.
To call a spade a spade, much of the reason the media and its popular pundits are so bullish on stocks at this time is because of the impressive rally — the pros don’t want to feel like they missed out, either. The core of their arguments is basically sound, however, and that argument is: Earnings are growing briskly, and that growth pace is picking up steam.
As of the latest look, Standard & Poor’s says the S&P 500’s earnings grew to the tune of 11.8% in the second quarter. The growth rate is projected to be 12.1% in the third quarter, 14.3% in the fourth quarter, and 16.6% in the first quarter of 2015.
No, the S&P 500 isn’t the same thing as PowerShares QQQ Trust. They’re not dissimilar, though. The biggest constituents of the ETF — names like Apple (AAPL) and Google (GOOG) are also the biggest names in the S&P 500 Index, and they represent a huge swath of the market.
Point being, earnings are growing marketwide, including for the companies in the QQQ ETF.
The Current Risks of the PowerShares QQQ Trust
While the S&P 500’s earnings growth rates are expected to get red-hot, the market’s valuation has already reached frothy levels. As of the end of last week, the S&P 500’s trailing P/E ratio is 17.6, the forward-looking (12 months) P/E is 15.3, and the average forward-looking P/E (10-year) is 14.1
Stocks have survived higher trailing P/E levels as well as higher projected P/E readings. They’ve rarely thrived once valuations made it that high, however. The QQQ ETF isn’t immune to the valuation problem.
At the same time, while the market’s momentum is more than impressive, each day that momentum prolongs the rally brings us one day closer to its eventual, inevitable end. And in the shadow of a 55% advance in less than two years with nary a correction in the meantime, all stocks and ETFs are more than pressing their luck.
To paint the picture with some numbers, the S&P 500 has rallied more than 1,000 calendar days without a correction of 10% or more. That makes it the fifth-longest correction-free rally since 1928.
Or, on a very low-brow level, traders should know that August typically isn’t a great month for the Nasdaq Composite — the average return for the index in August is a tepid 0.18%. But it’s September that should really worry QQQ holders — next month is the only month that is, on average, a loser for the Nasdaq. The average loss is a sizeable 0.62%.
Given how the PowerShares QQQ Trust is already up 12% year-to-date, a correction here and now could be considered right on cue.
After weighing the odds and comparing the pros and cons, it looks like the QQQ ETF is more of a liability than an asset at this point. It’s easy to like what you see based on the fund’s current momentum. But the momentum is only as long-lived as valuations and history say a correction can be sidestepped.
The rally from the PowerShares QQQ Trust is running on fumes. It’s time for a reset.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities.