Invesco QQQ Trust (NASDAQ:QQQ), an ETF designed to track the large NASDAQ stocks, has rallied big time over the past month. QQQ is now up nearly 10% since making recent lows in early October. It also just traded above $200 for the first time ever.
Some of the recent moves higher may be justified given the recent Fed rate cut. The red hot rally, however, has come too far, too fast. Now that momentum has slowed, an overbought and overvalued QQQ is due for a pullback.
Apple (NASDAQ:AAPL), Microsoft (NASDAQ:MSFT), Amazon (NASDAQ:AMZN) and Alphabet (NASDAQ:GOOG,NASDAQ:GOOGL) account for roughly 40% of the overall QQQ. These Four Horseman of the NASDAQ have all reported earnings with decidedly mixed results. Apple had a solid, if not spectacular report. Microsoft beat on both the top and bottom line but guided lower. Amazon and Alphabet both had big earnings misses.
Yet all of these stocks are now higher post-earnings. In the case of AAPL, and maybe MSFT, that makes some sense. The fact that Amazon and Alphabet are higher makes no sense at all, especially given how bad the earnings reports were. Both of theses stocks initially sold off sharply post-earnings but have since recovered all the losses and then some. Earnings will matter and momentum will ultimately end, perhaps in a not-so-pretty way.
QQQ Stock Charts
The current P/E ratio for QQQ is nearing a rather robust 26. This is a big expansion to the 23 multiple from a year ago. Both Apple and Microsoft now have a market cap over a trillion dollars, with Amazon and Alphabet not far behind. Growth rates for these giants will be hard to maintain simply due to the law of large numbers. The combination of higher valuations in the face of slowing growth means that P/E multiples will by necessity have to begin to contract. QQQ will likely head lower.
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The technicals are getting to extremes as well after breaking out past the $195 level. 9-day RSI breached the 70 level which has signaled a short term top in the past. MACD also reached a recent high before weakening. QQQ is trading at a large premium to the 20-day moving average as measured by the Detrended Price Oscillator. Previous instances when this occurred proved to be a prelude to a pullback.
More importantly, the price action yesterday finally gave an indication that the rally may be ending. QQQ traded up to fresh new all-time highs at $201.72 before pivoting to close off the highs at $200.43. This type of reversal pattern is indicative that a short-term top is in place. It is especially powerful following such a strong rally. The buyers may finally be exhausted and the sellers have taken charge.
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The VXN, a measure of NASDAQ stock implied volatility, is at recent lows. This is usually a reliable contrary bearish indicator that signals an overly complacent market.
The last time VXN was at similarly low levels was late July, right before QQQ suffered a serious pullback. It also marked a 3-month top for NASDAQ stocks. Look for a similar scenario to unfold soon.
Stock traders should look to short QQQ on any strength. The initial downside target would be a pullback to the convergence of the 20-day moving average and breakout level at $195. A continuation of the rally past $205 would be a viable stop out area.
Option traders may look to take advantage of the low levels of implied volatility to position for a pullback with a comparatively cheap diagonal. Buying the December $200 puts and selling the November $197 puts would cost $3.25. Maximum risk is $325 per spread. Ideally QQQ closes near $197 at Nov. 15 option expiration. The trade structure also allows additional selling of weekly options versus the long December puts to further reduce the initial cost if needed.
Tim Biggam may hold some of the aforementioned securities in one or more of his newsletters. Anyone interested in finding out more about Tim and his strategies can go to https://marketfy.com/item/options-and-volatility.
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