QQQ ETF: The rally is not the start of a new bull market (NASDAQ: QQQ)
NASDAQ 100 ETF (Nasdaq: QQQ) has seen a sharp rise in short-covering over the past several weeks as funds disposed of their portfolio risk. It has pushed the QQQ ETF up 23% since its June 16 lows. These types of rallies within secularism Bear markets are not all uncommon; Marches of similar or more significant size occurred during the 2000 and 2008 cycles.
To make matters worse, the price-earnings ratio for the Nasdaq 100 has risen again to levels that have put this index back in expensive territory on a historical basis. That ratio goes back to 24.9 times estimates for 2022 earnings, pushing the ratio to one standard deviation above its historical average since mid-2009 and to an average of 20.2.
Moreover, earnings estimates for the Nasdaq 100 Index are on the decline, down nearly 4.5% from a peak of $570.70 to about $545.08 per share. Meanwhile, the same estimates are up just 3.8% from this point in time a year ago. This means that paying nearly 25 times earnings estimates is no easy feat.
Real yields rose, making the Nasdaq 100 more expensive compared to bonds. The 10-year TIP is now trading around 35 basis points, up from -1.1% in August 2021. Meanwhile, the Nasdaq’s dividend yield has risen to around 4%, which means the difference between real returns and the Nasdaq 100’s dividend yield is just 3.65%. That spread between the Nasdaq 100 and the real return fell to its lowest point since fall 2018.
Financial conditions eased
The reason for the spread to shrink is that financial conditions are deteriorating. As financial conditions improve, it appears to be causing the spread between stocks and real returns to narrow; When financial conditions tighten, this causes the spread to widen.
If financial conditions ease further, there could be more multi-expansion. However, the Fed wants inflation to come down and is working hard to reshape the yield curve, and that work is starting to show up in Fed Fund futures, which remove the bearish pivot. Rates have skyrocketed, especially in the months and years after 2022.
But more importantly, for this monetary policy to spread effectively in the economy, the Fed needs fiscal conditions to tighten and to be a constraining force, which means the Chicago Fed National Financial Conditions Index needs to move above zero. When financial conditions start to tighten, this should cause the spread to widen again, further putting pressure on the Nasdaq 100 value and causing QQQ to fall. This could bring the price-earnings ratio for the Nasdaq 100 index down to about 20. With earnings this year estimated at $570.70, the value of the Nasdaq 100 would be 11,414, down nearly 16%, bringing QQQ back to the 275 range US dollars. to $280.
In addition, what we see in the market is nothing new or unusual. This happened during the last two bear markets. QQQ rose 41% from its intraday lows on May 24, 2000, up to July 17, 2000. Then, just two weeks later, it did so again, rising 24.25% from its intraday lows of August 3, 2000, through September 1, 2000. What followed was a steep sell-off.
The same thing happened from March 17, 2008 to June 5, 2008, when the index rose by 23.3%. The point is, these sudden, sharp rallies are not unusual.
This rally put the index and the European Investment Fund back into overvaluation and regained some of their recent declines. It also puts the focus back on financial conditions, which will need to tighten further to start having the needed effect to slow the economy and reduce inflation.
The rally, though bland, is unlikely to continue because the Fed’s monetary policy will need to be more restrictive to effectively return the inflation rate to the Fed’s 2% target, meaning wide spreads, fewer multiples, and slower growth. All bad news for stocks.