The Invesco QQQ Trust (NASDAQ:QQQ) stock is among the most highly-traded ETFs in the world.
There are lots of good reasons to look into this stock but for QQQ there is a particular draw.
Investors in the Invesco QQQ Trust are those looking for (relatively) diversified exposure to technology.
I say relatively because approximately 40% of the ETF’s holdings are in five stocks. These are:
- Apple (NASDAQ:AAPL) – 11.% weighting
- Microsoft (NASDAQ:MSFT) – 9.5% weighting
- Amazon.com (NASDAQ:AMZN) – 8.4% weighting
- Alphabet (NASDAQ:GOOG) and (NASDAQ:GOOGL) – 6.9% weighting
- Tesla (NASDAQ:TSLA) – 4.3% weighting
That said, these companies are some of the biggest in their respective fields for a reason. Many investors want to own ETFs that are heavily weighted toward such companies because the size of a given company’s market capitalization generally correlates with lower volatility and better risk-adjusted returns over time.
That said, bond yields appear to have poured some cold water on the recovery these technology behemoths have provided investors QQQ stock of late. Let’s take a look at why that’s the case.
Good News = Bad News For QQQ Stock
The difficulty many investors have with understanding why rising bond yields are generally bad for tech stocks is understandable. I mean, rising inflation expectations means the market is broadly pricing in an economic recovery. That’s a good thing, right?
Yes, it is. However, bond yields, and more specifically U.S. treasuries, are used as the risk-free rate in most valuation models. Rising bond yields move the risk-free rate higher, lowering the valuation of all stocks.
Now, given the stretched valuations across the board in the technology sector, these companies tend to be more sensitive to such movements. Any sort of small adjustment to key variables in a discounted cash flow model could result in relatively large swings for perfectly priced stocks.
With the Federal Reserve currently focusing on the short end of the yield curve, the market is currently determining prices on the long-end of the curve.
The U.S. 10-Year Treasury is the most-cited bond yield metric for a reason, as this is commonly used as the risk-free rate by many analysts in forecasting models. The U.S. 10-Year Treasury is near 14-month highs. Accordingly, investors are scrambling to re-do their models.
Conclusion
Generally speaking, technology stocks haven’t been this richly valued since the height of the dot-com bubble. The higher these stocks go, the more downside room exists for a potential decline.
This means investors really need to be precise with their use of growth rates, WACC, and the risk-free rate, as fluctuations can really impact the output value of the model.
What’s interesting to consider is how tech stocks performed during the most recent pandemic-driven selloff. These stocks actually outperformed most sectors, and a key reason for this is bond yields that imploded. Growth stocks tend to become a lot more attractive in an environment where investors are earning essentially nothing on their bonds.
Conversely, as bond prices drop (prices are inversely correlated with yield), fixed income assets become more attractive for portfolio allocators. Therefore, I’m expecting to see a continued growth-to-value rotation take place over the medium-term, barring any sort of Federal Reserve interference.
More specifically, I think highly-cyclical consumer discretionary stocks are likely to outperform.
History can teach us a lot of hard lessons. Many millennial investors may not remember the dot-com bubble implosion more than two decades ago. However, following this rout, it took the QQQ approximately 15 years to fully recover from a capital appreciation standpoint.
We’re still not necessarily at the valuations we were at in 1999/2000. However, tech stocks are certainly approaching those levels today. Investors should be aware of these risks, and be thinking really long-term with their investments today.
On the date of publication, Chris MacDonald held a LONG position in AAPL, MSFT, AMZN, GOOG.
