Which Nasdaq-100 ETF is Right for You?

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Which Nasdaq-100 ETF is Right

for You?

Dorsey Wright ETF Spotlight

May 2016

Market breadth is an important technique used in technical analysis, as it helps to gauge the general direction of the market. One way that we track market breadth at Dorsey, Wright & Associates (DWA) is through “participation” indicators, such as the Bullish Percent, which measures the percentage of stocks within a given universe that are on a Point & Figure buy signal. When more stocks are on buy signals, participation rates across a particular universe are much wider, indicating an expansion of market breadth. When fewer stocks are on buy signals, it is an indication that a lower number of stocks are participating in rallies, an indication of absolute weakness and potentially, lower market prices.

In the end, these indicators are simply a record of what is actually happening in the marketplace.

Over the past couple of months, we’ve observed some interesting developments take place on the Bullish Percent chart for the Nasdaq-100 (NDX) Index. We saw it rise up to its 2015 high of 78%, indicating that 78% of the Nasdaq-100 were on buy signals, and then ebb back down to the 52% level, indicating that over half of the Nasdaq-100 are on buy signals. While this indicator has ebbed and flowed in recent months, it is still well above its January 2016 low of 20%. The overall increase in buy signals has been a bullish sign for this particular segment of the market, as participation rates, ie: market breadth, has increased. To elaborate on the significance

the NDX Bullish Percent as well as what this means for the Nasdaq-100, it is worth taking a step back and reviewing what these two instruments represent.

To briefly review, the Nasdaq-100 is a modified

capitalization weighted index that tracks the largest non-financial companies listed on the Nasdaq Stock Exchange. The top 10 companies within the Index represent roughly 50% of the Index and often, but not always, may sway the direction in which the Index trades. The Bullish Percent chart is an oscillating indicator that gives each stock within the Index equal representation as it measures the percentage of stocks within a given universe that are on Point & Figure buy signals. In other words, the Point & Figure chart of NDX takes a cap-weighted approach to those 100 stocks and the Bullish Percent chart takes an equal-weighted approach to the same 100 stocks. With all of this in mind, we wanted to take some time and review the multitude of products on the market that track components of the NDX and the differences in how the products track the Index. As mentioned above, the chart of the NDX has returned to a near-term buy signal after falling into oversold territory. Additionally, many of the products that track the components of the Index are in oversold territory and may be worth watching to see if any of them may offer opportunity if they rally from these oversold levels. With that in mind, let’s take a look at some of the ETFs that track the Nasdaq-100 Index.

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Cap-Weight vs Equal Weight

The first ETF to begin tracking the Nasdaq-100 Index did so in March 1999, and in a rather conventional fashion, as it mirrors the “modified cap-weight” Index in the form of what is now the PowerShares QQQ ETF. The “Q’s” currently have more than $37 billion in AUM and will naturally behave very much like the largest components of the Index, as the top 10 stocks comprise over 50% of the Index (leaving the other 50% to the bottom 90 stocks), and the top two holdings (Apple and Microsoft) make up 20% of the Index.

The “Equal-Weighted” Nasdaq 100 Index (NDXE) tracks those same largest 106 non-financial stocks today, but does not

NASDAQ-100 INDEX

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weight them by means of market capitalization. Instead, the Index is equally-weighted at each rebalance date, bringing each component of the Index to a weighting of roughly 1%. In April 2006, First Trust launched the First Trust Nasdaq-100

Equal Weighted Index Fund (QQEW), which tracks this

version of the Nasdaq-100. The “Q’s” are essentially the House of Representatives of the Nasdaq-100, treating Apple Computer (AAPL) in much the way that the state of California has an outsized voting contingent within congress. QQEW is instead analogous to the U.S. Senate, where each state (read: stock) has an equal number of votes.

INTERMEDIATE-TERM SCALE TREND CHART PowerShares QQQ Trust (QQQ)

INTERMEDIATE-TERM SCALE TREND CHART First Trust NASDAQ-100 Equal

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As it stands today, the weight of the evidence is still positive for both ETFs as they maintain fund scores north of 3 (DWA Fund Scores range from 0.00 to 6.00 – the higher the score, the “stronger the fund.”)  When we take a look at the intermediate-term scale charts of both QQQ and QQEW, we see they both pulled back to test the August 2015 correction lows after rallying during October 2015. Both QQQ and QQEW fell to violate their correction lows in February, however, both have rallied considerably off those recent lows. The recent action on both trend charts confirms what we have seen transpire in the market recently in that some of the largest stocks on the market have fared slightly better than the somewhat smaller counterparts. To gain further perspective on the relationship, we look to the relative strength chart that compares QQQ vs QQEW. A relative strength comparison of QQQ vs QQEW must be conducted on a highly sensitive scale (we use 1.0% below) as these two funds are highly correlated due to owning the same securities. Today, that relationship favors the cap-weighted Q’s, as they have maintained an RS Buy Signal versus QQEW since August 2011. The performance dispersion over the past 4 1/2 years has often been very subtle but it has widened more recently, with shares of QQQ returning +94.06% and QQEW gaining+ 77.81% from 8/02/11 through 3/31/16. Both have outpaced the S&P 500 Index (SPX) over that time, which is up roughly +64.25%.

Relateive Strength Chart (1.0%) QQQ vs. QQEW

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Tech vs Ex-Tech

In 2006-2007, First Trust added a pair of products to their ETF lineup that allowed investors to delineate Nasdaq-100 exposure along sector categories, specifically Tech versus ex-Tech. The viability of these products, which total over $400 million in assets between the two today, speaks to the growth that the Nasdaq-100 has continued to experience through tertiary products even as it reaches the ripe old age of 31. The Nasdaq-100 inventory has evolved from the late-90s, at which point it truly was a “Technology” index, to its current composition today, which includes a greater

headcount of “ex-Technology” constituents. The First Trust

Nasdaq-100 Technology Sector Fund (QTEC) launched in

April 2006 with the mandate of tracking an equal-weighted basket of Nasdaq-100 components considered to fall within the broad Technology sector. Today, this fund invests in 36 such securities across the Semiconductor, Software, Internet, Computer Hardware, Computer Services, and Telecom sub-sectors. Meanwhile, the First Trust Nasdaq-100

ex-Technology Sector Index Fund (QQXT) invests in all the

“other” Nasdaq-100 companies, holding those in equal-weighted fashion as well.

INTERMEDIATE-TERM SCALE TREND CHART

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/ 5 Relateive Strength Chart (2.0%)

QTEC vs. QQXT

Both the “Tech” and “ex-Tech” products from First Trust that track Nasdaq-100 sub-indexes offer positive long-term trends (see charts above), with the Tech fund QTEC currently offering a stronger fund score at 3.50.  The relative strength chart between the two favors the QTEC as well. QTEC generated an RS buy signal versus QQXT in June 2014 and remains on a buy signal to this day. The comparison below is plotted on a 2% scale, which is less sensitive than the earlier RS chart (QQQ vs QQEW) as these two funds do not have any common holdings.

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Alternative Nasdaq-based ETFs

The Fidelity Nasdaq Composite Index ETF (ONEQ) launched in 2003 as a broader alternative to the Q’s, including exposure to the entire Nasdaq Composite Index of approximately 2,000 securities. It is a capitalization-weighted fund, and so much of its exposure is dedicated to the Nasdaq-100 components. In August 2012, the First Trust Nasdaq

Technology Dividend Index Fund (TDIV) began trading, which

uses a dividend value weighting methodology as well as a rising dividend screen to construct its portfolio. This fund does use an inventory beyond that of only Nasdaq-listed securities however. In February 2014, DWA partnered with

PowerShares and Nasdaq to enhance the PowerShares DWA

Nasdaq Momentum Portfolio (DWAQ) to track a relative

strength driven strategy. Like the two aforementioned funds, DWAQ is not bound by strictly the Nasdaq-100, but rather uses a starting inventory of roughly 1,000 Nasdaq-listed companies. From there, we employ relative strength to reconstitute the portfolio of 100 stocks each quarter. Nasdaq-100 components must earn their way into the portfolio with superior performance trends relative to other Nasdaq listings, and the current composition of DWAQ includes 27 such Nasdaq-100 components.

DWAQ currently has 19 holdings (out of 100) from the Nasdaq-100, with the remaining 81 being other high RS stocks listed on Nasdaq.

INDEX METHODOLOGY

Dorsey Wright Nasdaq Technical Leaders Index TLNadaq

Starting Inventory:

Nasdaq-listed securities

Eligibility:

1,000 common stock with largest market capitalization

Ranking:

All securities are ranked based upon relative strength against a common benchmark and each other

Stock Selection:

The Top 100 securities by relative strength ranking are selected

Index Weighting:

Securities are weighted by their relative strength score, higher scores receive large weights

Maintenance:

Dorsey Wright Nasdaq Technical Leaders Index rebalanced and reconstituted on quarterly basis

Index Inception: April 21, 2011

INTERMEDIATE-TERM SCALE TREND CHART

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© Copyright 2016. All rights reserved. Nasdaq® and the Nasdaq Stock Market® are registered trademarks, or service marks, of Nasdaq, Inc. in the United Stated and other countries. 0511-Q16

DISCLAIMER

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This report is for Internal Use Only and not for distribution to the public. While we make every effort to be free of errors in this report, it contains data obtained from other sources. We believe these sources to be reliable, but we cannot guarantee their accuracy. Investors who use options should read the Options Disclosure Document before making any particular investment decision. Officers or employees of this firm may now or in the future have a position in the stocks mentioned in this report. Dorsey, Wright is a Registered Investment Advisor with the U.S. Securities & Exchange Commission. Copies of Form ADV Part II are available upon request. Equity prices provided by Thomson-Reuters. Cross Rate prices provided by Tenfore Systems. Option prices provided by OPRA Copyright © 1995-2015 Dorsey, Wright &

Associates, LLC.®

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Nasdaq® and the Nasdaq Stock Market® are registered trademarks, or service marks, of Nasdaq, Inc. Statements regarding Nasdaq-listed companies or Nasdaq proprietary indexes are not guarantees of future performance. Actual results may differ materially from those expressed or implied. Past performance is not indicative of future results. Investors should undertake their own due diligence and carefully evaluate companies before investing. ADVICE FROM

A SECURITIES PROFESSIONAL IS STRONGLY ADVISED.

SUMMARY

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The purpose in discussing the different products on the market that seek to track the NDX is to show that ETFs give investors the ability to invest in many of the same stocks but take different approaches when investing within those stocks. NDX is not the only index that has a number of products on the market that approaches investing in the Index in different fashions. With this recent turbulent market, it is worth taking time to assess what the different products are that follow an index that your client may be looking for exposure to. Not only do these ETFs give your clients a myriad of ways to invest in certain segments of the market, but they also are useful in gaining perspective on the market or segment that you may be watching. With the Domestic Equity markets potentially showing the first signs of positive action from oversold territory recently, it is worth taking the time to look at the different products that may track an index you are looking to gain exposure to. One of them may be just what you are looking for and could be good additions to your shopping list for ETFs.

The ability to get more granular and focus on where we may want to gain exposure to an index is part of the innovation that ETFs provide to the marketplace.

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