Invesco QQQ quarterly outlook report

Market Performance

Invesco QQQ ETF (at NAV) returned -22.33% in Q2  and underperformed the S&P 500 by 6.22% which returned -16.11% as of 6/30/2022. The focus during Q2 was firmly on continued concerns around high inflation, and the response from the Federal Open Market Committee (FOMC), the branch of the Federal Reserve System that determines the direction of monetary policy. Prices continue to be pressured by a variety of factors including supply and demand imbalances, the ongoing war in Ukraine, continued supply chain issues, the resumption of travel across the country, and more, as the Consumer Price Index reached the highest level 1981 during the quarter.

QQQ’s overweight exposure to the Information Technology, Consumer Discretionary and Communication Services sectors were the largest detractors from relative performance against the S&P 500 Index. Information Technology averaged a 50.06% weighting in QQQ (vs. 27.05% in the S&P 500 Index) and fell by 23.11% (vs. 20.19% in the S&P 500) for the quarter. Overweights to Apple (down 21.59%), NVIDIA (down 44.43%) and Microsoft (down 16.49%) were the largest detractors from the sector. Consumer Discretionary averaged a 15.76% weighting (vs. 11.16% in the S&P 500 Index). An overweight position to Amazon.com was the largest detractor to relative performance in the sector and overall performance against the S&P 500 Index as the company’s stock fell by 34.84% for Q2. Amazon.com was under pressure for most of the quarter and sold off considerably following the release of its Q1 earnings. The stock fell by 14.05% on April 29, the session immediately following the release. Amazon reported Q1 revenue of $116.444 billion and a net loss of $3.8 billion or $7.56 per share, driven by a $7.6 billion loss on its investment in electric vehicle manufacturer, Rivian Automotive. The effects of higher inflation and continued supply chain challenges throughout the quarter continue to pressure expenses with the company reporting $112.7 billion in operating expenses for Q1. Amazon has taken steps to address rising expenses including an approximately 5% fuel and inflation surcharge announced earlier in April on sellers that utilize Fulfillment by Amazon, and an increase in the Amazon Prime membership fee from $119 to $139 announced in February, the first price increase for Prime in since 2018. The bright spot continues to be on Amazon Web Services, the company’s cloud computing division, where revenue grew by 37% to $18.4 billion. Investors focused on Amazon’s Q2 revenue guidance of $116 billion - $121 billion which missed the average analyst estimate of $125 billion.

Healthcare averaged a 6.12% weighting for the quarter within QQQ (vs. 14.31% in the S&P 500 Index) and traded lower by 15.13% (vs. down 5.90% in the S&P 500 Index). Intuitive Surgical was the largest overall detractor to relative performance in the sector, down by 33.47% in Q2.

Ultimately, there were very few places to hide, as every sector within the S&P 500 Index and QQQ ended Q2 in negative territory. Even Energy, which was the best performing sector in the S&P 500 for Q1, up 39% declined in Q2 by 5.29% and was only the third best performing sector in the market. Although the spot price of West Texas Intermediate crude oil (measured at Cushing, Oklahoma) advanced by 5.46% for the quarter, concerns around slowing growth likely the energy sector in negative territory. From the high level on June 8 at $122.11 per barrel through June 30 the spot price declined by 13.39% to finish the quarter at $105.76 per barrel Traditionally defensive sectors Consumer Staples and Utilities were the best performing sectors in the S&P 500 Index and traded lower in Q2 by 4.62% and 5.09%, respectively.

Single Stock Performance

The best-performing stocks in QQQ for Q2 were Pinduoduo (+54.08%), Seagen Inc. (+22.83%) and Monster Beverage Corp. (+16.02%). The worst performers for the quarter were Netflix Inc (-53.32%), AirBNB Inc. (-48.14%) and Illumina Inc. (-47.24%). 

Market Drivers & Outlook

Over the course of Q2, and 2022 thus far, growth-oriented companies and sectors have been under pressure, as higher inflation and the prospects for slower economic growth has weighed on investor sentiment. After Fed liftoff, (the Fed’s initial rate hike which raised rates off the target of 0.00% -0.25% in March), Q2 brought two additional rate hikes: a 50 basis point hike in May and an unexpected 75 basis point hike in June (one basis point is equal to 1/100th of 1% and is used to denote the percentage change in a financial instrument). The 75 basis point hike which raised the Fed’s target rate to 1.50%-1.75%¹, was somewhat of a surprise after Fed Chairman Jerome Powell made comments following the March FOMC meeting that investors could expect a 50 basis point hike in May and an additional 50 basis points, a standard measure for interest rates representing one-one-hundredth of one percent, in June. The more aggressive action by the Fed was on the back of a reacceleration in inflation as measured by Consumer Price Index (CPI)—the average change in prices over time that consumers pay for goods and services. Many economists had expected inflation to peak in March and then slow in subsequent readings. While the reading slowed slightly for April, to a year over year increase of 8.3% from 8.5%, The May reading showed inflation growing by 8.6%, the highest level since 1981. Energy costs rose by nearly 4% (3.9%) while food costs increased by 1.2%.

Looking ahead, tackling inflation will continue to be at the forefront of investors minds. On the morning of July 13, June CPI was reported at 9.1% year-over-year and 1.3% on a month-over-month basis. The reading represents a 40-year high as the last time CPI was over 9.0% was in late 1981. Higher prices for food (up 1% from May), gasoline (up 11.2% from May) and primary residence rent (up 0.8%). Core CPI, which excludes the volatile food and energy components rose by 5.9% year-over-year, higher than the average economist projection although slightly lower than May’s 6.0% reading. On the same day, US Real hourly and weekly earnings for June were released and declined by 3.6% and 4.4%, respectively, the 15^th consecutive decline in real wages. The question now becomes what action will the Fed take during their next meeting on July 26-27? After the June meeting, Fed Chairman Powell noted that a 50 or 75 basis point hike in July was most likely. Given the red-hot inflation number, could the FOMC decide to hike by 100 basis points at the July meeting? Alongside a more cautious Fed comes growing recessionary fears as aggressive tightening threatens to put the brakes on the economy.

The second part of the Fed’s dual mandate is employment. Employment had shown strength in Q1 after initial jobless claims fell to a 53-year low at 166,000 during the week-ended March 18. Over the course of Q2 however, initial jobless claims began to weaken and rose from a low of 168,000 for the week ended April 18, to a high of 233,000 for the week ended June 17. Between a softening employment market and lower real wages, the potential for impact on the US consumer, the largest component of GDP, increases. 

Amid the uncertainty around inflation, interest rates and recessionary worries there seems to be a potential shift in sentiment. As recessionary risks increase, timing expectations for future dovish Fed action begins to creep closer and closer. Following the June CPI release, Federal funds futures show that traders are now expecting the first rate cut in February 2023, rather than the expectation for March 2023 one day before the release of CPI. The question may no longer be whether or not the Fed can avoid a recession and engineer a soft landing, but when will the economy enter recession and when will the Fed reverse its hawkish stance on monetary policy.

As usual, QQQ investors will be watching earnings from heavyweight companies Apple, Microsoft, Amazon, Alphabet and Meta, all preliminarily scheduled to report earnings during the last week of July. Thus far in 2022, investors have paid keen attention to companies’ forward guidance (for those that issue it) or indications of impacts from higher costs, supply chain disruptions, etc. Additionally, mentions of disruptions from China’s zero-COVID policy will likely be scrutinized. The country’s aggressive stance which includes quarantines, factory closures, etc. has the potential to continue to weigh on strained supply chains and global growth on the whole.  

As we look forward to Q3 and the rest of 2022, companies that are able to deliver solid fundamental growth amid inflationary and supply chain headwinds will be more likely to be rewarded by investors. The market will remain laser focused on the Fed’s plain of action for reigning in inflation and whether aggressive action will push the US economy into a recession, The short-term is very hard to predict and sentiment is a challenging thing to quantify. However, one positive development is that valuations, arguably some of the biggest areas of pushback over the last two years, have declined considerably. Valuation of the Nasdaq 100 index (the index QQQ tracks finished the quarter with a trailing 12-month price-to-earnings ratio (P/E) of 24.16). Looking through a longer-term lens, this P/E level has not been seen since the early days of the pandemic (Q2 2020) and may represent an opportunity for investors to gain exposure to large-cap growth at the most attractive valuations in the past two years.