TQQQ: Triple Long, Triple Q Works Great At A Major Bottom, But Is A Rotten Idea Near A Market Top

Summary

• Selling/shorting the 3x leveraged QQQ ETF product could prove a great idea to either lock in gains (if held today) or hedge the downside of a potential bear market.
• Weakening technical action in both the TQQQ and QQQ ETFs may signal a trend change is at hand.
• TQQQ can decline markedly in price during a flat market period, from futures/swap time decay and a daily rebalance design.

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ProShares UltraPro QQQ (NASDAQ:TQQQ) is an exchange traded fund investing directly through derivatives in stocks of companies in the NASDAQ 100 index. TQQQ uses futures and swaps to create its portfolio, seeking to track 3x the daily performance of the underlying NASDAQ 100. Formed in 2010, this ProShares ETF seeks "daily" investment results, before fees and expenses, that correspond to three times (3x) the daily returns of the NASDAQ 100. And, over the last decade, TQQQ has done a nice job of delivering on its triple leverage goal.

This article will examine how the daily compounding and 3x leverage setup has performed over various market backdrops since 2015. A discussion of the topping action in the big-tech NASDAQ 100 stocks since August is also included. The conclusion drawn is now may be a good time to avoid ownership or sell the TQQQ product, until some sort of stock market correction takes place. A companion article here from late March, explains some bearish arguments for an approaching stock market peak, based on euphoric investor sentiment, rising interest rates, and fading breadth evidence.

Performance History

TQQQ has done remarkably well on a long-term horizon, using a buy-and-hold approach, although most financial advisors recommend against ownership past a few months. The main reason this ETF has outperformed over many years is based in the uber-bullish run by the big-tech stocks, despite a high 0.95% annual expense and futures ownership that decays in value. The market condition since 2016 has been labeled as Tech Boom 2.0, because it resembles the unbelievable technology run during the original 1990s Dotcom boom.

A secondary explanation for TQQQ's strong multi-year advance comes from daily rebalancing. The net effect of an index rising day after day, with a rebalance feature is the advance is "compounded," akin to pyramiding schemes with margin accounts. Below is a 3-year chart of total returns including dividends vs. the zero-leverage Invesco NASDAQ 100 ETF (QQQ), highlighting the positive advance, greater than a three-times design would imply.

Plus, if you can buy at a major stock market bottom, and hold during a monster advance like the span between April 2020 and today, the compounding effect really explodes your profits. The total return over the last 12 months has been 4x the QQQ gain!

However, if you buy near a stock market peak like today, rebalancing down days in price and time decay on futures and swap instruments become real headaches for trust owners. For instance performance during the first three months of 2021 have not lived up to the 3x goal, with roughly 2x the QQQ performance being achieved.

Then, when we review previous flat to lower spans for the QQQ (and market in general), TQQQ turns into a bigger loser than you would expect. Below I have charted the stagnant mid-February 2015 to early February 2016 period. A slight -1% total return loss from QQQ translated into a much larger negative return of -15% for TQQQ.

If you buy near a market top, and ride a bear market drop into the early phases of the next bull move, you will not be a happy camper. If you had purchased in August 2018 and sold in early January 2019, an investor would have locked in a loss almost 4x the -10% decline in QQQ.

Again, if you had purchased this leveraged ETF in early February 2020 as the pandemic numbers were skyrocketing worldwide, and held through the better than -28% decline in the QQQ into the recovery phase at the end of May, you would've been disappointed. TQQQ's net loss would have been -25% vs. a slight net NASDAQ 100 gain!

On a longer-view, had you bought before the panic selling early last year, and held until today, your net gain would only be 2x the roundtrip experience from top to top in the QQQ. [Although most investors would be quite happy with a 93% gain over 14 months.]

Technical Review of Big Tech

Why am I nervous about prospects for the U.S. stock market, and the NASDAQ 100 specifically, the remainder of 2021? I am finding far weaker technical trading action in 2021 vs. 2020. With the QQQ product reaching a new closing high Friday April 9th, a number of divergences in breadth have appeared.

For starters the simple measure of NASDAQ advancing vs. declining issues daily is shouting an unhealthy condition now exists. The tech-heavy NASDAQ market of thousands of stocks has seen fading participation by individual names since February. And, today's failing A/D Line is similar to the situation in late August into September, circled in red, that presaged the last 10% QQQ drop during September-October.

Some volume data is even more worrisome than the autumn correction in the NASDAQ 100. Namely, a running total of the difference in up and down volume is screaming significant selling has hit big-tech leaders. The September-October decline in price saw no real slowdown in volume accumulation patterns. Since the middle of February, sellers have been more aggressive, boxed in blue.

The QQQ chart over the past year shows the once leading NASDAQ stocks have been sharply underperforming the Dow Jones Industrial ETF (DIA) since early February. Often at a top, the leading generals of the advance (the NASDAQ 100 during 2021) will fade quickly as the Dow Industrials continue zigzagging higher a few more months. That describes the April 2021 condition exactly!

In addition, On Balance Volume basically peaked for the QQQ ETF in early September, seven months ago. The 14-day Money Flow Index is also screaming a short-term top could be at hand in coming days, if past patterns hold, circled in green.

For TQQQ, the flat to weaker span since early February is causing some issues for daily compounding and derivative decay. Against the main QQQ investment product, the 3x leveraged ETF is having issues keeping up.

Just like the QQQ chart, OBV trends have been weakening for many months, and the MFI is signaling an overbought condition is approaching fast.

Final Thoughts

I last mentioned TQQQ as a short/hedge candidate in January 2020 here, just as the novel COVID-19 virus was starting to make the news in China. I was personally short TQQQ during the panic selling of February-March 2020, related to pandemic fears. It was a wonderful hedge position in my portfolio. And, while I have not been short this 3x leverage ETF since last March, I am entertaining the idea again in April 2021. With a top formation playing out during early 2021 for the main NASDAQ 100 index, I absolutely rate the shares as an Avoid and Sell currently.

Shorting the product may fit into the portfolio creations of more seasoned and diversified investors. You can use a price decline, daily compounding, and time decay in futures and swap positions to your advantage, with limited dividend and margin costs at many online discount brokers.

What would change my mind? That's a good question. The Federal Reserve and Uncle Sam seem to be boxed into a period of rising interest rates and less deficit spending, as the economy recovers from the coronavirus (after vaccinations and herd immunity spread peak this spring). An elevated interest rate picture is my biggest worry for the big-tech sector of the market, offering less support for clear fundamental overvaluations. The NASDAQ 100 is priced around 40x trailing 2020 earnings, double the level of five years ago (or 12 months ago for that matter)!

Image Source: DailyFX Website

When you throw in rising interest rates, the likelihood of higher taxes for corporations soon, truly euphoric investor surveys this year, and weakening breadth participation for months in the general market, the outlook and rationale for an investment in TQQQ is turning more bearish every day. If you think about it, today's setup for the NASDAQ 100 is the exact OPPOSITE of the bullish backdrop of one year ago.

It's hard to imagine valuations becoming even more stretched with corporate and high net-worth tax rates all but certainly going up in 2021. As Biden and the Democrats now control the purse strings of government, they are intent on tilting the tax code toward America's leading technology giants, including shareholders.

Of course, a continuation of slight gains in the NASDAQ 100 is possible, as long as interest rates rise slowly, and no new black swan events appear. Outside of increasing interest and tax rates, geopolitical tensions between Ukraine-Russia, China-Taiwan, and North/South Korea could generate new selling in global stock markets. Major wars tend to freak out investors, at least initially. Again, another disruptive black swan on top of the coronavirus issues of early 2021 could send TQQQ into a tailspin, with losses amplified by a factor of 3x (or more if it is a protracted decline).

To sum up any bullish view of TQQQ today, plenty of variables need to barrel ahead in your favor. From my risk-reward analysis of a U.S. market reaching for a top, holding a short position as a hedge against other long choices, makes more sense. If you prefer to control risk, perhaps a 15-20% stop-loss level would be helpful on your short sale, just in case the NASDAQ can somehow remain in an uptrend into the summer months.

Thanks for reading. Please consider this article a first step in your due diligence process. Consulting with a registered and experienced investment advisor is recommended before making any trade.

Analyst’s Disclosure: I am/we are short DIA. 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.

I may initiate a short position in TQQQ, QQQ over the next 72 hours. This writing is for informational purposes only. All opinions expressed herein are not investment recommendations, and are not meant to be relied upon in investment decisions. The author is not acting in an investment advisor capacity and is not a registered investment advisor. The author recommends investors consult a qualified investment advisor before making any trade. This article is not an investment research report, but an opinion written at a point in time. The author's opinions expressed herein address only a small cross-section of data related to an investment in securities mentioned. Any analysis presented is based on incomplete information, and is limited in scope and accuracy. The information and data in this article are obtained from sources believed to be reliable, but their accuracy and completeness are not guaranteed. Any and all opinions, estimates, and conclusions are based on the author's best judgment at the time of publication, and are subject to change without notice. Past performance is no guarantee of future returns.