Investing in the QQQQ is Like Eating Cotton Candy For Dinner

Investing in the QQQQ (or the NASDAQ 100) is like eating cotton candy for dinner...there's no redeeming value in doing it.  While it won't kill you, it won't do much good for you, either.  The fundamentals are uninspiring, the technicals have broken down, and sentiment isn't negative enough to form a good bottom. 

First, the fundamentals are uninspiring for three of the four horsemen of the QQQQ - Dell, Microsoft, Intel and Cisco.  You don't have to be technology analyst to realize that PC sales growth is slowing.  Consumers and companies are focusing on mobile technologies and pushing more information out of the office.  That trend makes the PC as a relic.  Until Microsoft releases it's new operating system, VISTA, there's no catalyst for PC sales to increase.  The weaker PC sales and resultant pricing pressures have caused the earnings estimates for the entire QQQQ to be revised downward.  For 2006, the earnings estimates for the NDX have gone from $74.40 to $61.57 over the past three months.  And while DELL, INTC and MSFT don't make up the whole NDX, that index finds itself lacking many of the leading stocks in the Energy and Materials sectors.  In fact, those two sectors make up less than 1% of the weighting of the NDX.  Technology, on the other hand, makes up 62% of the NDX weighting.  It all adds up to a stagnant outlook for the QQQQ.

   

Source: Baseline

Second, the technical picture for the QQQQs doesn't look much better.  The QQQQ have broken a long term up trend line in place from April lows.  Yet the QQQQ's aren't oversold on the longer term stochastics.  While the market could rally back to test the breakdown at the $41.50 level, I think the QQQQ could move lower and fall into a trading range between $38 and $40.50. 

Source: Stockcharts

Finally, while sentiment is negative, it's no where near as pessimistic as it needs to be to form a sustainable bottom.  For instance, the 10 day moving average of the call put ratio has spiked higher recently indicating that traders were hoping for a rally.  I believe that the call put ratio has to trend back to the lower end of the range before a more durable negative sentiment bottom can be put in place.  You can see that the 2005 April bottom wasn't formed until the 10 day moving average of the call put ratio bottomed at 140. 

Source: ISE

The one positive in the QQQQs favor is valuation.  The NDX hasn't traded at a lower P/E multiple in over 15 years.  I believe that this will put a "valuation floor" under the larger tech stock, despite the lower earnings estimates.

Source: Baseline

If you're an investor or trader, look for something more fulfilling than the QQQQs. 

Comments

[muckdog]

Mmmm... cotton candy! Well, on the sentiment front, I've noticed folks more concerned about trying to time the "snapback rally" than who are scared that we may go down further. I think this is a bullish bent to the market. We probably need to enter a frustrating trading range for a while where the market goes nowhere and we see a sea change. Those who are worried about missing a snapback rally will eventually be more concerned about missing the next down leg, and that's when we'll have our setup. JMHO!

[cd]

I love cotton candy for dinner. Why does it always have to be about nutrition?