Invesco QQQ ETF: The Nasdaq Declines May Be Far From Over

The Nasdaq 100 ETF (QQQ) has entered a bear market, with the ETF down more than 20% from its intraday highs at the end of November. The declines may worsen, potentially by another 7% to 13%, before they start to get better.

The problems for the QQQ may not be visible on the surface but are very easy to see below the surface, as liquidity in the Nasdaq 100 futures thins out and bid-ask spreads widen. On top of that, the Russian invasion of Ukraine has sent oil prices soaring. It comes as financial conditions continue to tighten, as investors price in a more aggressive Federal Reserve and an increased risk of a global recession.

The risk for a recession is most visible in the yield curve. The spread between the US 10 Year rate and the US 2 Year rate has fallen to 25 bps. It is an indication that the bond market is increasing the risk of a potential US recession.

PE Multiple Compression

The rising fears are leading to market-wide compression in earnings multiples, and given how high those multiples had been, they are only now getting back to pre-Covid levels. It means those multiples have even further to drop. The underlying Nasdaq 100 index is currently trading for 22.7 times its next twelve month’s earnings estimates. Since 2012, that index has had an average PE ratio of 21.1. But if you strip out the period after March 2020, that average is much lower, at just 17.8. It would imply that there is still a lot of risk for further multiple contraction for the Nasdaq 100. While 17.8 seems unlikely, given the Covid lows were higher and around 18.2, it does give us a sense of the potential downside, which would be a contraction of more than 13%, placing the Qs around $279.

The risk of such a drop is probably higher than one would imagine. Several indicators show that liquidity in this market is very thin and that financial conditions are getting tighter. These issues make for very volatile intraday trading as investors look to reduce their risk exposure levels, especially going into a period where the Fed is going to start raising rates and higher oil prices.

Liquidity Thins Out As Financial Conditions Tighten

The latest data from the CME shows that the depth of book for the Nasdaq 100 is still thinning out, which means there are fewer contracts on the bid and ask. Additionally, the spread between the bid and ask prices has widened.

Stress has also shown up in the overnight funding markets, as noted by the three-month LIBOR rate minus Federal Funds rate, which has climbed. Additionally, we see the iShares 7-10 Year Treasury Bond ETF (IEF) to iShares Investment Grade Corporate Bond ETF (LQD) ratio surging, both indicating tightening financial conditions.

With the combination of high oil prices and the potential for the Fed to start raising rates as soon as next week, these financial conditions may stay tight or tighten further. None of which will be good for the liquidity and functioning of the market. Coupled with a need to reduce risk exposure due to the rising uncertainty that oil price will have on the economy is likely only to weigh more in the coming days.

Technical Support Approaches

It has the QQQ ETF approaching some critical support around $317. Should that level of support break, there is minimal support until $300, a drop of another 7%. It would take the QQQ ETF back to levels not seen since November 2020. The relative strength index certainly suggests the momentum is very bearish and that there is plenty of room for the ETF to fall further.

It is a turbulent time for the market. Where the QQQ ETF and the markets are heading may have more to do with the rising risk of a recession and its liquidity.

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