Soon, fall leaves will give their best impression of this year’s US stock market – lots of falling.
Barring a miraculous run-up to the end of the year, major indices will end in the red for the first time since 2018. That means the ETFs they track will pull many investment account values down after three years of double-digit gains.
Over the next four months, two of the most popular ETFs, the SPDR S&P 500 ETF Trust (NYSEARCA:SPIE) and the Invesco QQQ Trust (NASDAQ:QQQ) vie for the dubious honor of the 2022 “winner.” Together, the funds have more than $500 billion in investor assets.
Last year’s race came to a close with SPY sticking its nose out for a 28.7% to 27.4% win. It ended a four-year winning streak for QQQ including the beating from 48.4% to 18.3% in 2020.
Despite their potential to produce dramatically different returns, SPY and QQQ have a lot in common. Since 2000, the correlation of their annual returns has been a remarkably high 0.92. That makes sense, since more than three-quarters of QQQ’s positions are also in SPY – and the top positions are very similar.
However, there are also some subtle differences that can explain major differences in performance. It is these differences that will determine whether SPY (-17.4% year-to-date) maintains its lead over QQQ (-25.8%) and lands its first back-to-back title since 2005-2006.
#1 Risk on or risk off?
If the economy fends off recessionary pressures and inflation shows signs of cooling, this would likely be a welcome development for equity investors. In turn, a less aggressive Fed would be the icing on the cake. This could lead to improved consumer confidence and market sentiment. The opposite scenario of continued inflation, deep recession and aggressive Fed policies could make matters worse.
In the bullish case, stocks would revert to “risk-on” mode. The advantage would go to QQQ. Why? The Nasdaq-100 index usually outperforms when markets move higher. This reflects the higher component risk and beta of 1.29 compared to the broad US market. In the bearish scenario, the less risky S&P 500, followed by the SPY, would likely outperform.
#2 Industry Performance
We often hear the Nasdaq referred to as the “tech-heavy” index, and it is. Nearly half of its weight is in the technology sector. S&P 500technology names account for about a quarter of the benchmark.
In both cases, technology is the largest sector weight, but it is the double weight in QQQ that accounts for much of the daily return differentials with SPY. Tech is the worst performing sector so far this year and a major reason why QQQ is lagging. More of the same would almost score a W for SPY, while a fourth quarter technical rally is QQQ’s best hope for a dramatic comeback win.
The energy sector could also play a role. By far the best performing economic group to date, even SPY’s 4% energy weighting could contribute to outperformance. There are no energy names in QQQ.
Then there are finance. They are the third largest sector in SPY with a 13% weighting but represent less than 1% of QQQ. Strong bank earnings reports, boosted by higher interest rates, could really help SPY move away from QQQ.
#3 Large stock of influencers
On an individual stock level, SPY and QQQ appear to be close relatives when comparing their respective top positions. In fact, the top five are identical: Apple, Microsoft, Amazon, Tesla and Alphabet. However, what is not identical is how much the big five is weighted in each fund. They own more than 40% of the QQQ portfolio. In SPY, their combined weighting is a more diluted 22%.
This means that the relative weight of these leading horses can lead to large yield differences. Apple is the best example. It has a weight of 13.7% in QQQ and a weight of 7.3% in SPY, a difference of 6.4%. So when Apple stocks outperform the S&P 500, the Nasdaq, and therefore QQQ, has a good chance of outperforming.
The same goes for stocks like Microsoft, Amazon and Tesla, which have a significantly greater weight in QQQ. Unfortunately for QQQ investors, all three SPY underperformed year-to-date, offsetting Apple’s modest outperformance.
Weights aside, 62 of QQQ’s 102 positions lag SPY year-to-date. This, in addition to risky trading, a tough year for technology, and certain mega-cap underperformers have made it virtually impossible for QQQ to gain ground on SPY.
A summer run did help QQQ close the gap on SPY briefly before Fed Chair Powell’s aggressive tone gave up about half of his gains. As the bull market-friendly QQQ has beaten SPY more often than not over the past 20 years, it should never be counted. But a lot will have to fall into place before the tech-dominated fund can win in 2022.