QQQ: Beware The Concentration Bubble

Introduction

With market focus reaching ranges final seen through the Nice Melancholy [1929-1932] and fairness valuations sitting at traditionally elevated ranges [S&P 500 (SPX) Shiller PE ratio: 36.2x], I believe it’s imprudent for long-term buyers to dismiss the concept of a “Focus” bubble within the inventory market.

Within the first half of 2024, the S&P 500 (SPY) gained +15.1%; nevertheless, simply backing out Nvidia’s (NVDA) inventory efficiency would lead to a drop to low-double-digit features for the remainder of the S&P-500. And if the “Magnificent-7” have been excluded, the S&P-493 gained simply +4%.

Taking a look at it differently – with greater than 80% of S&P-500’s efficiency coming from 20 largest shares – the continuing inventory market rally is clearly top-heavy, i.e., concentrated within the largest capitalization shares.

Now, based mostly on relative efficiency, the large-cap, tech-heavy Nasdaq-100 ETF (NASDAQ:QQQ) has been outpacing the broader market [S&P-500] fairly considerably on 1, 3, and 5-year timeframes.

On the flip aspect, small-cap shares merely refuse to take part on this bull run and are curiously flat year-to-date regardless of boasting comparatively engaging valuations. Sadly, such poor market breadth resonates with late-cycle conduct and is traditionally inconsistent with actual bull markets, which are usually broad-based in nature.

Demystifying The Market Focus

Whereas GenAI breakthroughs and hype have definitely performed an enormous function in turning investor sentiment from “extraordinarily bearish” on the October 2022 lows to “extraordinarily bullish” proper now, the buying and selling a number of enlargement in an already richly-valued mega-cap tech basket may be reasoned for based mostly on their earnings development:

For context, in Q1 2024, “Magnificent 7” firms delivered year-over-year earnings development of fifty%+, whereas the “S&P-493” produced little to no development final quarter. Given their important enterprise outperformance, buyers can’t be blamed for flocking into extremely worthwhile, money wealthy, globally dominant tech platform firms amid persistent macroeconomic uncertainty.

Nonetheless, with the large earnings development benefit for mega-cap tech names anticipated to shrink in coming quarters, a rotation commerce from “Magnificent 7” shares to “S&P-493” seems to be a really doubtless near-term consequence.

With “S&P-493” ahead P/E a number of sitting at ~20x, the projected earnings development acceleration from low-single-digits to mid-teens might already be priced in, and even when it isn’t, the upside appears restricted. However, a slowdown in “Magnificent 7” earnings development to the high-teens by Q1 2025 might spark a painful imply reversion in buying and selling multiples for these mega-cap tech shares.

QQQ Is The Epicenter Of The Focus Bubble And Might Get Hit Exhausting

On condition that QQQ’s top-10 holdings—mega-cap tech shares [barring Costco (COST)]—command 51.3% of the Nasdaq-100’s weight, I believe it’s honest to view QQQ because the epicenter of the focus bubble.

Within the occasion of a imply reversion in mega-cap tech shares, QQQ might get hit laborious, given its excessive focus in a number of choose names. Momentum is a double-edged sword that cuts each methods, on the upside and on the draw back.

Technical Setup Calls For But One other Correction

In QQQ: Put together For Turbulence, we mentioned the pivotal function of liquidity within the ongoing inventory market run-up, and known as for a correction:

From a technical perspective, QQQ is presently “Overbought,” and its chart displays a rising wedge bearish sample and unfavourable divergences in momentum indicators corresponding to RSI and MACD.

Can the fairness markets hold coiling increased within the wedge? Sure, equities can stay overbought and maintain elevated valuations so long as liquidity is considerable. As we famous in right now’s article, the RRP facility nonetheless has ~$400B, and the Fed is trying to sluggish QT “pretty quickly.” Nonetheless, with the Financial institution of Japan ending its unfavourable rate of interest experiment lately, the reverse Yen carry commerce might result in market liquidity drying up in a jiffy.

As such, prudent buyers have to be ready for a breakdown of the rising wedge, i.e., an imminent pullback in QQQ. The character of such a pullback could possibly be corrective (brief, shallow) or impulsive (lengthy, deep), given the lopsided run-up has left a large air pocket beneath!

For the reason that publication of that report in March 2024, QQQ has undergone a corrective (brief, shallow) pullback to ~$410, solely to rebound sharply to new all-time highs. In latest weeks, QQQ has been coiling increased in a re-test of the rising wedge trendlines, and is now sitting on the doorstep of $500:

Regardless of widespread FOMO, I believe a serious reversal is imminent, with Q2 2024 earnings season simply across the nook. Whereas QQQ is about to check a serious psychological stage at $500, QQQ is fairly “overbought” as soon as once more and bearish triple unfavourable divergences on momentum indicators [weekly RSI and MACD] name for yet one more pullback!

The July-October interval is seasonally weak for tech shares (and the fairness markets typically). Moreover, US elections are arising in November, and volatility might decide up earlier than we head into the Fall showdown.

Closing Ideas

Mark Twain as soon as mentioned –

Historical past does not repeat itself, nevertheless it typically rhymes.

Earlier episodes of maximum inventory market focus [like the one we are witnessing today] have led to busts.

Because the 12 months has proceeded, fewer and fewer shares have pushed the inventory market returns in 2024. The truth is, present worth motion in fairness markets is eerily just like the setup described by Stanley Druckenmiller:

Now, I’m not calling for a “1987-Black Monday” crash within the inventory market, however I do imagine the chance of an impulsive pullback in QQQ is non-zero, given excessive focus threat tied to the richly-valued mega-cap tech “Magnificent 7” basket, which is about to bear a large earnings development slowdown in upcoming quarters.

With financial information beginning to present cracks in latest weeks, anticipation of a Fed fee lower is rising quickly, and the bond market has priced in additional than 70%+ chance of a lower on the September FOMC assembly. An easing of financial coverage (enhancement in monetary liquidity) might assist increase asset costs; nevertheless, buyers ought to thoughts the lag results and keep ready for turbulence!

Key Takeaway: I fee QQQ a tactical “Promote” at present ranges.

I will depart you with this thought:

Investing will assist you to construct wealth, however threat administration will assist you to keep rich

Thanks for studying, and glad investing. Please let me know when you have any ideas, questions, and/or considerations.