When Iwrote about itNasdaq trackerfonds Invesco QQQ Trust ETF (NASDAQ:QQQ) last December, year-to-date [YTD] performance was remarkable. With an increase of 54%, the index easily outperformed the S&P 500 (SP500) index, which itself had shown a healthy increase of 24%.
QQQ continues to grow in 2024 with an increase of 9% YTD. But here's the twist. It has lost its lead over the SP500. In fact, it lags slightly behind the index (see chart below). It's not hard to see why. Persistent macroeconomic risks and the fund's high valuation are likely to catch up. This doesn't mean that the drive for forward movement has dried up, just that it now looks relatively diminished. Here's how you do it.
The American economy is strong, but is in danger of weakening
Consider firstmacro economy. So far, the growth of the US economy continues to surprise positively. The second GDP estimate published last month reflects thatan annual growth of 3.2%in the fourth quarter (4th quarter 2023). This is lower than the 4.9% increase in the third quarter of 2023, but still significantly higher than the trend growth of just over 2%. GDP also exceeded the trend for the whole of 2023 by 2.5%. This in turn gives greater confidence in the potential development of the shares, at least in the short term.
Unless, of course, growth slows down as much as expected. This is expected to reach 2.1% in the first quarter of 2024an investigationof 34 professional forecasters, a decrease of more than 1 percentage point compared to the previous quarter (see table above). How far this will go, however, remains to be seen for two reasons. Firstly, it has been significantly upgraded from the previous forecast of 0.8% and secondly, the average forecast for full year 2024 is for growth of 2.4%, which is slightly lower than last year.
The forecasts indicate that while there is no serious threat to the economy from a slowdown this year, there remains a risk to stock returns if the economy does indeed slow down.
Subsidizing inflation and interest rates can support margins
But even if growth slows, the edge could be blunted as inflation continues to fall. Inflation has remained relatively mild, at 3.2% annualized in February, which alone increases the chances that the economy will stay on track for the rest of 2024. Furthermore, there is a good chance that interest rates will fall later this year, as the figure is expected to fall below 3% this year (see the link to the survey of professional forecasters above).
So far, the Fed has resisted cutting rates as inflation has remained above its 2% target and the economy remains resilient. However, if the above predictions are correct, slowing growth and lower inflation could lead to interest rate cuts. This in turn is positive for net margins as the pace of cost increases slows, especially interest costs.
Potential for a rise in prices of the largest companies
At the largest holding companies, the story is largely the same as a quarter ago. First, the inventory remains the same, although the weights have been shuffled a bit. Microsoft (MSFT), NVIDIA (NVDA) in the Amazon (AMZN) now have larger shares.
Of these, only Apple (AAPL) a Tesla (TSLA) have seen a price drop YTD, while the rest continue to rise (see table above). However, this is not something to ignore. By 2023, all stocks had seen a price increase, with both Apple and Tesla contributing in no small part, with increases of 55% and 134% in 2023 when I last wrote.
At the same time, it's worth noting that the top 10 stocks still look good in terms of valuation. This is how you do it:
- The average weighted price-to-earnings ratio for these investments has actually fallen to 33.8x, from 37.3x when I last wrote.
- Five of the ten largest holding companies are still trading below their five-year average price-to-earnings (P/E) ratio. Of these, Amazon (AMZN) continues to look promising and deeperinventory analysisshows that there will be even more benefits in 2024.
- Despite four of the five top 10 stocks trading above their five-year average price/earnings even in December, their prices have also continued to rise, indicating that they are now relatively more highly valued.
The key takeaway here is that while there is still room for further upside in the key positions, there is also some risk of correction in the future, as already evident from recent developments for two of these stocks. Since the last time I checked, the price/earnings of the ETF as a whole is up ~33xtot 34,4x. It also remains higher than the S&P 500at 28.4x.
Of course, positions are likely to change if there are among the top performers, which in turn guarantees a level of return for QQQ. The fund's 412% return over the past ten years is indicative of its superior performance over time.
The issue of consumer discretionary demand
The fact that the YTD return of 9% is lower than the weighted average return of the top 10 investments of ~22% reflects that there is traction from other sectors. The consumer discretionary sector, the ETF's second-largest sector holding at 19%, is likely to blame. The S&P 500 Consumer Discretionary Index rose just 4% from last year. The sector could remain a weak spot for the QQQ into 2024 if growth cools as expected, although dramatic declines are ruled out.
What's next?
In summary, however, there is some potential for QQQ to continue rising through the remainder of 2024 based on the performance and valuations of the top 10 holdings. It also helps that inflation is moderate, interest rates can fall and a hard landing of the US economy is largely excluded.
But the economy could still cool, especially in the current quarter. Two of the top 10 stocks have seen declines since the start of the year, as opposed to all 10 that posted good returns the last time I checked. Weak price growth in the consumer discretionary sector is also an indication that this second-largest sector interest could negatively impact returns.
Overall, the likelihood of strong growth in 2024 is smaller. However, the long-term returns are remarkable, as are the credentials of the top holdings. Investors with a medium to long-term time horizon are likely to benefit more from investing in the fund now than those looking for relatively short-term returns. I'm keeping a purchase, but with a longer period in mind.
