In last week’s Capital Ideas column, I compared the Direxion Nasdaq-100 Equal Weighted Index (symbol: QQQE) exchange-traded fund (ETF) to the Invesco Nasdaq 100 ETF (symbol: QQQ) ETF. QQQ tracks the Nasdaq-100 index, which allocates proceeds on a market-weighted basis. What does “market-weighted basis” mean? The larger a company’s market capitalization (defined by the number of shares outstanding times the share price), the more significant its allocation. For example, QQQ holds behemoths like Microsoft, Apple, and Nvidia, each with about an eight percent allocation. Said another way, those three companies represent nearly one-fourth of the Nasdaq-100 Index. Amazon represents an additional five percent of the index.
QQQE also invests in companies found in the Nasdaq-100 index; however, it is an equal-weighted fund, which means the ETF targets a one percent allocation of each company.
I hold both QQQ and QQQE in my portfolios. Given that it has been the largest of the large-cap companies that have propelled the market over the last year, I argued that QQQE “allows me the technology sector exposure I want (about 40 percent), but with less concern about whether the largest of the large-cap stocks are overheated and ready to fizzle out.”
It is appropriate to share some nuance on how overextended, or not, the Nasdaq may be. To do so, we will examine the Nasdaq Composite stock market index as a proxy for the Nasdaq-100 index. The two indices are not identical (the Nasdaq-100 currently does not include any significant allocation to financial and energy companies), but they are similar enough. The Nasdaq market-weight index may be more extended than its equal-weight counterparts, but it still aligns with historical trajectories, per data compiled by DataTrek as of mid-July 2024.
The Nasdaq Composite has rallied 80 percent since its December 2022 low. While impressive, it lagged the average of the Nasdaq’s recoveries from previous lows.
The current Nasdaq recovery remained nine percentage points behind the average of the previous four recoveries. Statistically, that is more of a “tie” than a “loss.” The current recovery could be nine percentage points ahead of the average and the point would remain that the pace of the index’s advance has not been so torrid that investors should expect a crash. Still, consolidation should be expected and viewed as healthy. Below is a comparison of the current recovery of the Nasdaq to its four prior rallies of the lows.
DataTrek observed that the lag of this recovery was likely due to the market’s uncertainty about when the Federal Reserve would start cutting interest rates. That may explain some underperformance; however, at the end of 2023, the futures market was nearly certain that the Fed would cut rates as many as six times in 2024. As I had said at the time, that proved wrong, but that didn’t make investors any less sure at the time.
Narratives are easy to build but difficult to prove. But if DataTrek’s observations are correct, the Nasdaq should take off once the Fed starts cutting rates. However, an inflation report on July 11, 2024, was so good that the futures market immediately began to price in rate cuts, and the Nasdaq closed down two percent. If there is another reason for the Nasdaq’s underperforming recovery than interest rate uncertainty, my premise remains that consolidation is more likely than a crash. Either way, I remain comfortable with my QQQ exposure and expect less downside from QQQE.
Nvidia is a big part of the Nasdaq
I can hardly make it out of the local coffee shop without someone asking me, “Is it too late to buy Nvidia?” Not only is the stock about eight percent of the Nasdaq, but the stock has been on an unbelievable ride higher. As a contrarian, I view rampant interest (euphoria?) from investment civilians as more of a negative than a positive for the stock. But momentum is powerful, and the company’s earnings growth has been stellar. I can Steelman a triple of the stock’s price and Strawman a 90 percent crash. Bring this article to your financial advisor to discuss its appropriateness for your financial plan.
I will share more of DataTrek’s numbers to help you with that conversation and give some additional perspective. Below is a chart that shows the compounded returns of Cisco, Intel, Microsoft, and Oracle in the five years through the Nasdaq’s March 2000 peak, indexed to 100.
Those four stocks were high-flying darlings during the technology bubble of the late 1990s and early aughts. They were up an average of 1,794 percent over those five years, compared to 3,063 percent for Nvidia. And below is that same comparison with those four stocks broken out individually.
We have all been inundated with comparisons of Nvidia to Cisco Systems and the crushing weight of Cisco’s falling stock price after its top in 2000. The company’s earnings fell from $2.67 billion in 2000 to $1.01 billion in 2001, and its stock price dropped nearly 90 percent from its peak. That is the bad news.
The good news is that Cisco’s earnings were $12.6 billion in 2023—yet its stock remains 40 percent off its 2000 peak. The Nasdaq has almost quadrupled since the 2000 peak. I am not advising long-term investors to avoid high-flying stocks; they can pay off. However, I want to draw your attention to the portfolio protection that diversification provides.
Allen Harris is an owner of Berkshire Money Management in Great Barrington and Dalton, managing more than $700 million of investments. Unless specifically identified as original research or data gathering, some or all of the data cited is attributable to third-party sources. Unless stated otherwise, any mention of specific securities or investments is for illustrative purposes only. Advisor’s clients may or may not hold the securities discussed in their portfolios. Advisor makes no representations that any of the securities discussed have been or will be profitable. Full disclosures here. Direct inquiries to Allen at AHarris@BerkshireMM.com. Adviser is not licensed to provide and does not provide legal, tax, or accounting advice to clients. Advice of qualified counsel or accountant should be sought to address any specific situation requiring assistance from such licensed individuals.
