As most of you know, the Invesco (QQQ) ETF is based on the NASDAQ-100 Index and as a result has been one of the best performing ETFs over the past 10 years – its 625% return over that time frame has been more than 2x the return of the S&P500 (which hasn’t done so badly itself):

Source: Seeking Alpha

Let’s take a closer look at the NASDAQ-100 and see what has been the secret to its success.

Sector Weighting

The largest sector in the NASDAQ-100 Index is the Information Technology, or “IT” sector, which has grown to become nearly 50% of the Index:

Source: Invesco

It’s important to realize that the definition of IT has evolved over the years. The sector now includes companies involved in R&D and the distribution of technologically focused products and services. This includes the makers of hardware like computers and smartphones as well as the semiconductors that power them and the software they run on. Also in the sector are companies that supply digital enterprise systems for businesses.

Some investors might be surprised to find that a semiconductor company like Nvidia (NVDA) is now classified by the NASDAQ as an “IT” company. As a result of this broad definition, five of the QQQ’s top-10 holdings are IT companies:

Source: Schwab (red stars added by the author)

Other IT companies in the NASDAQ-100 include semiconductor makers Intel (INTC), Texas Instruments (OTC:TI), Broadcom (AVGO), and Qualcomm (QCOM).

There are three macro-trends that will likely keep these IT companies powering the QQQ higher for many years to come.

Cloud Computing

The first macro-trend is cloud computing. As my recent Seeking Alpha article on Cloud Computing ETF (SKYY) pointed out, data from the Gartner Group indicates cloud revenue in 2022 is expected to be ~$106 billion higher than full-year 2020 expectations:

Source: Gartner July 2020

Also note in that article that two of the “Big-3” providers of cloud computing include Amazon (AMZN) with AWS and Alphabet (GOOG) with GCP. The other member of the Big-3 is Microsoft with Azure. If we glance back at the previous table of the QQQ’s top-10 holdings, one could argue that we could put at least half an asterisk next to AMZN, GOOG, and GOOGL since cloud services clearly fall under the IT domain. Doing so would arguably put eight of the QQQ’s top-10 holdings in the IT sector that in aggregate would account for an index weighting of ~50% IT just in the top-10 holdings alone. Clearly cloud computing exerts a strong force on the QQQ.

You’ve probably heard the saying “data is the new oil”. Nothing is more emblematic of that statement than the recent ouster of Exxon (XOM) from the DJIA while Salesforce.com (CRM) was added. Salesforce blew away Q2 EPS estimates (see the Q2 report) and is currently trading up 14% in pre-market trading. Just to be clear, Salesforce is not in the QQQ – it is listed on the NYSE. But the point is this: cloud computing is a primary and powerful driver in the IT sector, and thus on the QQQ.

READ ALSO  It's Coming... A Huge Bond Buying Opportunity

Meantime, note how the “Dow Jones Industrial Average” is no longer made up of industrials – the IT sector has taken over (as it has the S&P500):

For another perspective on how the cloud is impacting businesses, consider reading my recent article on Adobe’s (ADBE) new Saas (“software-as-a-service”) business model: the Creative Cloud.

5G

The next macro-trend likely to provide a positive tailwind for the QQQ for years to come is global adoption of the 5th generation of the mobile network: 5G. The new global wireless standard enables a new kind of network that is designed to connect virtually everyone and everything together – including machines, objects, and devices. 5G technology will deliver higher multi-Gbps peak data speeds, ultra low-latency, higher reliability and a more uniform experience to users. Higher performance combined with massive network capacity will enable new user experiences and new industries.

Clearly 5G phones are a primary investment thesis for Apple, the QQQ’s largest holding with a 14.5% weighting. According to Strategy Analytics, a total of 234 million 5G-enabled smartphones could be sold this year – 15% of overall sales. In comparison, just 18.6 million 5G-ready smartphones were shipped in 2019 – which implies sales are on track to rise by 12x. One analyst predicts the 5G smartphone market will reach 600 million units next year, with Apple making 24.2% of those sales. NASDAQ-100 semiconductor suppliers like Broadcom and Qualcomm will also be prime benefactors of the move to 5G.

While some have argued that the COVID-19 pandemic has had a “pull forward” effect on tech stocks, when it comes to 5G, it had the opposite effect. Broadcom CEO Hock Tan spoke about this on the Q2 conference call:

Nothing has changed in terms of designs. Nothing has changed in terms of the content you indicated. And you’re right, the content has been up for 5G phones over 30% – way over 30%, more close to the 40% from where we were last year. It’s just the timing, and we’re guiding Q3, and I don’t mean to be rude, but we’re not guiding Q4 at this point.

Tan basically suggested that the expected Q2 bump due to 5G, was effectively pushed out into Q3. That’s because the pandemic caused manufacturing shut-downs and supply-chain issues during Q1 and Q2.

The Global Internet of Things (“IoT”)

Lastly, the IoT investment thesis builds on the foundation of the 5G network just discussed. According to Intel, the IoT is going to have a dramatic effect on industry and the economy over the next 3-5 years, and likely for many years to come:

Source: Intel

READ ALSO  Exploration Activity Offshore Norway Plunges After Oil Price Crash

IoT projects will be powered by:

  • Edge Computing
  • Cloud Computing
  • AI and Computer Vision

PRN Newswire reported that Verified Market Data recently estimated that the IoT market will have a market worth of $1.3 trillion by 2026 and deliver a CAGR of 25.7%. It says the crucial aspect of the rise in IoT market revenue will be the development of wireless networking technologies such as Wi-Fi, Bluetooth, ZigBee, Z-Wave, Insteon, and Digital Enhanced Cordless Telecommunications will lead to a larger base of individuals interested in purchasing IoT devices.

The report says major players in the IoT market include QQQ holdings Intel, Cisco, Microsoft, Google, and Amazon. Not sure why the report did not mention Apple – clearly many of the apps that will control IoT devices will be running on a 5G smartphone.

The Lines Blur

Note how the lines are blurring between these industries. Alphabet is technically not an IT company, but has a top-3 position in the cloud. Tesla (TSLA) is an automotive maker, but its innovation and success in autonomous driving will ultimately depend on AI and computer vision, which according to Intel is a prime driver behind the IoT. Meantime, the semiconductor companies in the QQQ will be providing the chips that make all of these technologies “tick”, whether it’s cloud computing, data center servers, smartphones, or AI.

Risks

The risk of investing in the QQQ are obvious: the market has been on a tremendous run since the pandemic induced March low and the QQQ is up 40% YTD. Meantime, the disconnect between Wall Street and Main Street has never been more apparent: there’s a global recession, the unemployment rate is above 10%, and tens of thousands of small businesses have closed. Everyone is waiting for a market correction – specifically in the high-flying tech stocks that have led the market and that have been responsible for the excellent out-performance of the QQQ. This led Seeking Alpha contributor Damon Verial to write The 2020 QQQ Tech Bubble.

But many investors were spooked out of the market during the March sell-off and now suffer from the dual afflictions of FOMO (fear of missing out) and FOGBI (fear of getting back in). These investors would love to initiate a position in a high-tech ETF like the QQQ but are hesitant to pull the trigger at what arguably could be a market top, with the valuation of companies like Apple and Tesla being exhibits #1 and #2. But the tech sector keeps going up day-after-day and if one or more COVID-19 vaccines are approved and distributed, and as therapeutic treatments evolve, markets could bounce higher still.

At the same time, holding money in cash is a losing proposition as interest rates are so low, conservative savers are getting severely penalized because real interest rates are negative (inflation is higher than the interest earned on savings accounts).

READ ALSO  National Guard Responds As 1000s Of Looters Ransack Philly In 2nd Night Of Chaos; Reporter Brutalized By "BLM Rioters"

Yet COVID-19 continues to see widespread infection and transmission rates as we head into flu season and could easily dampen economic activity even more going forward. And, of course, we are heading into a very contentious November election. On the other hand, the pandemic has accelerated the work-from-home (“WFH”) movement, which is increasing the need for many of the technologies discussed in this article. As mentioned earlier, some investors and analysts believe the WFH development has “pulled forward” much of the revenue expected over the next couple years to this year, and that the next couple of years will be relatively soft by comparison. That certainly wasn’t true for Broadcom – a big supplier of 5G components – and it is an argument that – so far as the market is concerned – is losing.

With all these mixed narratives and uncertainties, what’s an investor do?

Summary & Conclusion

The answer to the question for a long-term oriented investor is to invest. And, as I have outlined in this article, in the long-run technology is going to be the engine behind global economic growth for many years to come.

That said, given the astounding run-up in the market, the prudent thing to do would be to analyze your portfolio to determine the total allocation of funds you would like to devote to the QQQ and then ease into it. Consider making a small starter position and then add to it on a weekly or monthly basis for whatever time-frame you are comfortable with. With such a strategy, you would then be able to take advantage of a significant market correction to consider making a larger contribution to your QQQ position.

Disclosure: I am/we are long AMZN, AVGO, GOOG, XOM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am an engineer, not a CFA. The information and data presented in this article were obtained from company documents and/or sources believed to be reliable, but have not been independently verified. Therefore, the author cannot guarantee their accuracy. Please do your own research and contact a qualified investment advisor. I am not responsible for the investment decisions you make.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.



Via SeekingAlpha.com