QQQ: Have We Seen The Highs?

Summary

• Forceful rallies in QQQ seem to have reached a point of exhaustion.
• Further downside extensions in QQQ would create a topping formation that is unlikely to reverse in thin summer trading conditions.
• Price levels at 136.20 present a critical inflection point that looks as though it will see an imminent break.

In a recent article covering the PowerShares NASDAQ Trust (NASDAQ: NASDAQ:QQQ), we recommended that investors remove exposure based largely on the fact that the earnings outlook for tech stocks is not as optimistic as most analysts had previously suggested. To this, we can add the fact that bull rallies in QQQ were far more massive than anything seen in the SPDR S&P 500 ETF (NYSEARCA: SPY) or SPDR Dow Jones Industrial Average ETF (NYSEARCA: DIA) during the same period. This disconnect between market price activity and the underlying fundamentals should have been enough to signal major red flags for investors, and we are already trading 4% lower in roughly one week of holiday-interrupted trading. This leaves us with the central question of whether or not we have seen the yearly highs in QQQ, and there are significant reasons to believe that this might actually be the case. Here, we will look at some of the reasons QQQ is likely to underperform its major counterparts in the second half of this year -- and this should be viewed as another recommendation for investors to take a more protective stance in the ETF.

From a comparative perspective, this three-month chart in QQQ should make it clear that the ETF is not exactly a perfect match for investors that are looking to avoid volatility. Over the last few months, we have seen some significant differences in the earnings performances for the companies that make up the ETF. For the most part, the better-known blue chip names have held up their end of the bargain while smaller companies have languished and this has made it very difficult for the market to come up with a stable trend direction in QQQ. This on its own might be enough to deter some investor types from initiating new long positions but there are other factors at play that could darken the picture even further.

Perhaps most important is the overall inflation picture, which is likely to be disproportionately influenced by the extended decline in oil prices. Reduced inflation expectations could keep the Federal Reserve from raising interest rates as aggressively as initially expected at the beginning of this year. And while this is generally viewed as a positively for the stock market as a whole, it is an event that should have far greater impact on instruments like SPY and DIA when compared to QQQ. Lower energy costs should have only a marginal impact on the cost reduction performances seen in tech stocks, so there is much less to get excited about if you are an investor with significant exposure to QQQ.

From a price perspective, CCI readings have turned exceedingly bearish and the lack of positive momentum here suggests that there is very little standing in the way of a break of support at 136.20. This area marks the base lows from the middle of May and the 100-day exponential moving average, so the confluence of events here suggests that we are likely to see a large number of stop losses tripped if the declines do continue. Further extensions would create a topping formation that is unlikely to reverse as long as we are holding within the thinner trading conditions that are typically seen during the summer period.

Of course, there is some degree of speculation here as the Fed could ignore the changing inflation trends and hold true to its initial interest rate timetables. But even in this alternate scenario, QQQ would likely face headwinds based on higher interest rate arguments. In any case, we are seeing slight bounces on the very low time frames but these are looking unconvincing and it seems that it is just a matter of time before we see a downside break of critical price zones at 136.20.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.