Since the start of 2023, we’ve seen a relentless advance in the markets. That’s been particularly true of growth-oriented stocks, and those that suffered the largest losses in 2022. There is plenty to worry about for investors in 2023, including a possible recession, the state of the yield curve, inflation, etc. However, stocks are ignoring that and simply going higher.
It appears at this point that the October low has a very good chance of being the low. I happen to be very bullish for 2023, and I think we’re going to end the year much higher than we are now in the major indices. The path to get there is somewhat up in the air, in terms of whether we get a test of the recent lows or not, but the action to start the year is reaffirming for me the idea that we’re going higher.
If that’s the case, one may seek to gain exposure to growth-oriented names, and my preferred way to do that is through the Nasdaq-100. The easiest way to do that is to own the QQQ ETF, but for those seeking leverage, the TQQQ offers 3X the daily return of the QQQ.
The ProShares UltraPro QQQ (NASDAQ:TQQQ) offers 3X the return of the QQQ over a single day of trading. In other words, if one measures over a period of more than a single day, the return of TQQQ is likely to be something other than 3X the QQQ. Because returns compound from one day to the next, holding TQQQ over long periods results in tracking error, and potentially significantly so. Thus, TQQQ – and other leveraged ETFs – should be viewed as trading instruments, not buy-and-hold instruments.
To demonstrate this risk of owning TQQQ, we have month-to-date returns for January of TQQQ and the index it tracks at a 3-to-1 rate, the Nasdaq-100.
The moves are much more pronounced (obviously), but during periods of prolonged weakness or strength, the compounding nature of TQQQ means returns can be significantly higher or lower than 3X. On January 20th, for instance, QQQ had returned ~2.5% MTD, while TQQQ was up ~8%. One might expect TQQQ to be up 7.5% as that is 3X the QQQ’s returns, but because there was a strong bullish move, returns were greater than the stated 3X. Over longer periods, this tracking error can be significantly more than 0.5%.
The point of all of that is to say that if you’re going to own TQQQ, or any other leveraged ETF, understand that it isn’t a perfect 3-to-1 instrument over time, which can exacerbate the inherent leverage of the product.
Now, let’s take a look at the weights of the companies in the TQQQ from the fund fact sheet.
Apple (AAPL), Microsoft (MSFT), Amazon (AMZN), Tesla (TSLA), and Alphabet (GOOG) collectively comprise about 43% of the fund’s holdings, so concentration is pretty extreme. This is hardly different from the Nasdaq-100’s holdings so that shouldn’t be a surprise, but like the tracking risk, concentration is another risk to consider and understand before buying.
Now that the disclaimers are out of the way, let’s take a look at the outlook for TQQQ, and why I think 2023 is a great year to be prudently exposed to leveraged ETFs, if you’re so inclined.
A sustainable bottom?
Let’s begin with the chart of TQQQ itself, and then we’ll look at the QQQ, which will give us an unleveraged look at the index TQQQ tracks.
We can see TQQQ has been mired in a nasty downtrend for more than a year, and the fund has lost the vast majority of its value over that period. That’s the risk of holding a leverage product long-term; during bearish moves, a standard bear market in the index can result in 75% losses or more in the leveraged product. That’s what we saw in TQQQ in 2022, but I think the risk is firmly to the upside in 2023.
Why? We can see the fund put in a big positive divergence between the October low and the January low, which simply means price tested the low while momentum – as measured by the PPO – put in a significantly higher low. That means selling momentum has waned, and therefore, a trend change is much more likely. If that’s right, that means the bullish move we’ve seen to start January may be just the beginning for 2023. That’s exactly what I’m expecting for this year, so we’re off to a good start.
Now, given that we’ve had a sizable bullish move already, I’m not suggesting you run out and put 100% of your money into TQQQ right away. In fact, I think we’re due at least a small breather, and potentially a shallow pullback, before we continue higher.
If we look at the PPO panel above, I’ve drawn a horizontal line to show the histogram of the PPO, which measures the rate of change between the slower and faster lines on the PPO. In essence, this measures the gap between the two, indicating whether the ETF is being overbought or oversold too quickly. The histogram is right at the level where previous advances have slowed and reversed, and while this is not a guarantee it will happen again, it certainly makes it more likely.
We have a similar story with the 14-day RSI, which finished Monday at 62. Again, that’s about the level where previous advances have taken a breather. Another point on that is that bear market rallies tend to have trouble cresting 60 on the 14-day RSI, while bull market moves tend to stay above 40 on pullbacks and reach 70 or 80 on rallies. If I’m right that we’re in for a bull market this year, that will be one clue; the 14-day RSI should see a character change where the rallies reach overbought levels, and the instrument never goes oversold. I don’t think that is happening as we speak, but I don’t think it’s far off.
One final point on this being a point where we could use a breather is on the 10-day rate of change in the very last panel. We can see the TQQQ’s 10-day ROC is a staggering 23%+, which, like the other indicators, is right where previous rallies have rolled over.
The confluence of these indicators all pointing to the same thing – the need for a breather – makes me cautious in the very short-term. However, the fact that we’re seeing such bullish action to start the year reiterates in my view that we’re going to have a strong year this year in the indices. I just think we need a pullback first, and the moving averages in blue and red above would be logical places to add exposure, if you’re also bullish. The 50-day SMA is currently just over $20, and the rising 20-day EMA is $19.28.
Let’s take a look now at the unleveraged Nasdaq-100 ETF, the QQQ, to get an idea of what the index that TQQQ tracks at a rate of 3-to-1 looks like.
The chart is similar to TQQQ, for obvious reasons, but if you’re going to own any leveraged product, it is my opinion that you should study the unleveraged version of the instrument you own. That’s simply due to the inherent distortion of trend moves in leveraged products, in terms of making trends look better or worse than they are in the underlying, unleveraged instrument.
At any rate, we see the same sorts of characteristics here, where it looks to me like the bullish move is a bit overextended, and is in need of a pullback. I won’t repeat all the same points, but again, the 50-day SMA in blue, and 20-day EMA in red above, at 278 and 276, respectively, look like great places to add exposure.
There’s resistance above in the 290 to 295 range, but I fully expect that to give way in the coming weeks.
Final thoughts
The bottom line is that I think we’re in for a sizable bull market this year. If you’re so inclined, I think leveraged instruments like TQQQ can provide capital efficient exposure to that bull market, but only if you understand the risks of owning it. One is tracking error, and the other is that if I’m wrong and we get another big bearish move, leverage ETFs could lose the majority of their value again.
I like TQQQ on a pullback to $20.00 to $20.50, and given that the current bull move looks overextended in my view, I don’t think we’ll necessarily have to wait that long. I’m slapping a buy rating on TQQQ, but with the caveat that the buy rating takes effect on a pullback to the moving averages, not right this second.
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