Nasdaq At Heightened Risk To Market Shock

by: Markos Kaminis


The Nasdaq Index is at heightened risk to market shock due to its very nature, higher beta coefficient and richer P/E valuation.

The Russian aggression in Crimea this past spring set a precedent showing heightened Nasdaq sensitivity.

As Russian troops again threaten, I suggest investors in the Nasdaq and QQQ ETF are at heightened risk. Aggressive investors might consider the ProShares UltraShort QQQ to benefit.

The PowerShares QQQ (NASDAQ:QQQ), which tracks the Nasdaq-100 Index, is at a heightened risk level if markets are shocked by an event such as a Russian breach of Ukrainian territory. In a recently published article, I suggested investors not be lulled by temporary geopolitical calm, and suggested they sell stocks, namely the S&P 500 Index. However, the Nasdaq-100 is at heightened risk to market shock and should be expected to contract at a greater rate and to a more significant degree in such a scenario.

Click to enlarge

1-Year Comparison of QQQ & SPY

You can see in the chart here that in the spring of this year, the PowerShares QQQ closed greater downside ground than the SPDR S&P 500 (NYSEARCA:SPY), which tracks the S&P 500 Index. The catalyst at the time was Russian aggression and intervention in Crimea. I'm suggesting the same thing will occur in the days and weeks ahead as Russia effectively invades Eastern Ukraine and annexes it, in my view.

The Nasdaq-100 is made up of very large companies, similar to the S&P 500. However, the index is often referred to as the "tech-heavy Nasdaq," as it tends to incorporate a greater degree of technology firms. The Nasdaq-100 and the QQQ incorporate approximately 60% information technology names. The SPDR S&P 500 includes less than 18% IT names, as the S&P 500 is a more broadly diversified index. Because of its greater degree of IT concentration, the QQQ tends to trade at a higher P/E ratio than the SPY, and it also carries a larger beta.

The S&P 500 is "the market" and so is the benchmark that securities are marked against to determine beta coefficient. The QQQ has a beta of 1.07, which illustrates a slightly higher degree of sensitivity to macro drivers. The QQQ beta is so close to 1.0 because it is made up of the top 100 Nasdaq names, and those are companies well-entrenched in the American economy and making money, so they are less risky than you might think. Many of the names in the Nasdaq-100 are also found in the S&P 500, so we're essentially looking at similar portfolios. Still, they are somewhat different, and so I am able to make this distinction.

The P/E ratio of the Nasdaq-100 is 20.29X, versus the P/E of the S&P 500, which is now 19.04X. The higher P/E of the tech-heavy index shows a higher degree of growth expectations for the companies inside the index. They are valued more richly because of these expectations. For the same reason, they are more vulnerable to market shock. In fact, both the higher beta and higher P/E offer evidence of this macro sensitivity.

Given the fact that the Nasdaq-100 reacted poorly to Russian aggression in the spring, and due to its riskier nature as indicated by its beta coefficient and its richer P/E ratio, I suggest holders of the QQQ sell the ETF.

Investors intent on maintaining an invested position could exchange the passive position in the QQQ for a portfolio of select stocks, and consider hedging risk against the sensitive Nasdaq by using the ProShares Short QQQ ETF (NYSEARCA:PSQ) as well. Aggressive investors might seek to benefit from this viewpoint by taking a long position in the ProShares UltraShort QQQ ETF (NYSEARCA:QID), which seeks a 2X inverse performance relationship to the Nasdaq-100 Index. Concluding and reiterating, it's my view that the Nasdaq-100 and the QQQ could put capital at greater risk than investments in the S&P 500 over the near term.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.