TQQQ ETF: Be Careful With Too Much Leverage After The Run-Up In The NASDAQ

Main Thesis/Background

The purpose of this article is to evaluate the ProShares UltraPro QQQ ETF (NASDAQ:TQQQ) as an investment option as its current market price. This is a leveraged fund with an objective to seek “daily investment results, before fees and expenses, that correspond to three times (3x) the daily performance of the Nasdaq-100 Index”. As a result of this objective, the fund is highly susceptible to big swings, as its history illustrates quite clearly:

As you can see, a 3X strategy will often result in big moves in both directions. Over the past year, this has been a big winner, with most of the gains coming from January.

This momentum is surely raising eyebrows and interesting swing traders. Because this option clearly does well in a bull market, there could be merit to trying to ride further momentum here. But there are a few key reasons why I believe readers should approach this fund – and similar types of strategies – carefully at this time. Some macro-headwinds exist that could limit further gains. If that turns out to be the reality, then TQQQ will be a risky place to be.

A Word Or Two On This Strategy

I want to begin this review with a direct discussion on what TQQQ. It is a 3X leveraged fund – and those types of funds should be approached carefully and may not be right for everyone. This is true regardless of any particular fund or investment environment. Leverage makes a fund more risky inherently, so weigh this when evaluating your own individual outlook.

How TQQQ works it is gives investors exposure to the underlying NASDAQ index and generally will move in correlation as the Invesco QQQ Trust ETF (QQQ) (but at 3 times the rate). To do this, TQQQ owns stocks, but also derivatives. These “swaps”, as well as other debt products, amplify the returns (and losses) for TQQQ compared to QQQ:

This has a few implications. One, TQQQ’s use of debt and swaps amplifies the potential gains, but also risks and expenses. This is why TQQQ has an expense ratio near 1%, which is quite high for an ETF. As a result, investors are taking on quite a bit of risk but also are paying quite a high fee (relatively) to hold this exposure. As a result, readers should be prepared to enter in to this trade on a short-term basis, in my view. Expenses will eat away at returns over time and the potential for large losses means this isn’t best for a “buy and hold” approach. Could one be successful doing that? Yes. But it is not something I would recommend for the average person.

Note: Most leveraged ETFs (such as TQQQ) are only designed to accomplish the stated leveraged objective on a daily basis. These funds are clear in their acknowledgment that returns may lag their stated objective over a longer period. Returns can differ significantly from the performance (or inverse of the performance) of their underlying index or benchmark over the same period of time, which can make these products risky long-term-or even medium-term-investments, especially in volatile markets. For more information, please consult guidance from FINRA here.

Why Caution Now? Best Start In Years

The fundamental thesis in this piece is not that TQQQ is a bad fund or that Tech or the NASDAQ index are bad investments. Quite the contrary – and Invesco QQQ is a fund I have owned for years. However, that does not mean I want to buy it at any price or any time. Whether it is any stock, fund, sector, or general idea – I want to be selective. In this vein, I have concerns about getting too aggressive on the NASDAQ index. This puts a risk-on fund like TQQQ on the backburner for now.

So let’s examine why that is. One reason is that the NASDAQ is performing well, perhaps too well! After a poor 2022, the Tech sector has been on fire in 2023. On a year to date basis, the NASDAQ has delivered its best start to the year in more than twenty-five years:

There isn’t a lot to dislike about this chart if you are a current investor. Gains have been strong and consistent on a year-to-date basis. And there is a very real possibility that more gains could continue.

But the challenge here is determining how attractive new positions would be at these levels. For me, I think this type of out-performance (in terms of the rest of the market and the NASDAQ’s own history) suggest we may be gearing up for a cooling off period. Given TQQQ’s leveraged approach to this index, that means patient investors can probably get a better entry point in the future.

Big Gains With Lower Volatility (Warning Sign)

Aside from the strong gains in the NASDAQ, there is a bigger concern for me right now. This has to do with the lower amount of volatility in the index. It has been trending lower for most of the year in a very consistent basis. In fact, the current volatility measure is near the 1-year low:

Again, this may not seem “bad”. It really isn’t for people who own TQQQ (or any other fund that tracks the NASDAQ). The gains have been large and steady. That’s the beauty of low volatility – it removes the wild swings.

So that begs the question – why might this be a problem? The concern I would have here is that low volatility doesn’t last forever. The NASDAQ can be a more volatile index and when we see a streak of passivity like this, it is probably signaling a reversal ahead. The takeaway for me is that we want to buy in to sectors or ideas when the market is panicking or stacked against that idea. Right now, funds like TQQQ are soaring on a very relaxed investment sentiment. That is not the strongest “buy” signal for the contrarian – and helps to justify why I have a “hold” rating at the moment.

Rally Is Starting To Move Beyond Tech

Another point to consider is that this bull market is starting to broaden its reach. While Tech has been outpacing the rest of the market, we are starting to see other themes make up ground in June:

If we learned anything from 2022 to 2023, it is that winners and losers can change on a dime. The top performing sectors in 2022 (Energy and Utilities) are not doing so hot this year. By contrast, Tech has been the big winner after falling hard the year before.

I bring this up because we may be seeing a bit of a rotation now. After such a strong run, Tech could be ready to give up some ground to other sectors. While this may be healthy for the market overall, it wouldn’t be an ideal for those who own (or want to buy) TQQQ.

Recession Fears – Overblown?

My last thought touches on the constant “recession” mantra we have been hearing about for years now. It seems as if the recession keeps getting pushed out to the point where it may not happen until 2024 (or later) at this point. It has solidified some of the resiliency of the U.S. economy – along with the effectiveness of fiscal stimulus. With stocks tending to fall leading up to, and during the onset, of a recession, this has surely been top of mind for many.

Personally, I think 2022-23 is good support for why most investors need to stay invested for the long haul. Economic cycles come and go and we simply can’t predict them. Just look at how many self-described market experts have gotten the recession timing wrong. Waiting for a recession and a subsequent drop in share prices that may never materialize could leave investors waiting on the sidelines. There is a risk to doing that for too long as inflation eats away at cash balances.

But there is a difference between staying invested and taking on too much risk for this stage in the cycle. Using TQQQ as a leveraged play should be done carefully and perhaps not at a time when the economy is weakening. While I am not going to surmise when an “official” may actually begin, there is no disputing a slowdown is occurring. We are starting to see wage growth stall a bit and inflation has come down. The latter is probably a good thing long-term, but its implication is that slower growth is ahead:

I tie this back to TQQQ to illustrate why I am reluctant to amplify my risk. I will stay invested, but will refrain from taking extreme risk-on bets at the moment. The NASDAQ has already had a strong run, volatility is too low for my liking, and economic indicators are suggesting challenging times ahead. It is hard to make a “buy” case with this backdrop in my view.

Bottom-Line

TQQQ has a history of big swings, so investors need to time this one carefully. With the run in the NASDAQ, and TQQQ by extension, already in 2023 my thinking is that those who don’t already own it have probably missed the boat. Better to wait for Tech share prices that could offer a cheaper entry point than to take on too much risk now and get burned. There is no real need to chase gains here with non-leveraged funds like QQQ delivering rates well above inflation (and the rest of the market) anyway. Therefore, I see “hold” as the right rating for TQQQ, and recommend readers approach it selectively going forward.