Are Equity Valuations Really that Pricey? Explore Growth with 'QQQ'

Cyclical and value stocks are showing signs of life, but the growth factor shouldn’t be written off. Particularly not when equity valuations aren’t as frothy as many investors previously believed.

Those are encouraging scenarios for the growth-heavy Invesco QQQ Trust (QQQ).

QQQ tracks the widely followed Nasdaq-100 Index (NDX), which is dominated by the technology, communication services, and consumer discretionary sectors. Those exposures are meaningful in the current market environment.

“Equity valuations have been top of mind after major stock indexes have scaled new highs. Last week’s volatile market moves as a result of technical deleveraging added fuel to these concerns,” according to BlackRock research. “We do not see risk asset valuations as obviously stretched overall, and expect low interest rates – and a vaccine-led restart – to support risk assets over the next six to 12 months.”

QQQ 3 Month Performance

QQQ: The Foundation for Growth Exposure

Growth stocks can be seen as exorbitant and overvalued, causing some investors to favor value stocks, which are considered undervalued by the market. Value stocks tend to trade at a lower price relative to their fundamentals. Yet growth may be ready for a comeback.

“Assessing equity valuations can be difficult. Structural shifts such as persistently lower interest rates make it difficult to judge the signals from traditional metrics such as price-to-earnings ratios. The key question is whether the compensation investors are getting to take on additional equity risk, after factoring in current low interest rates, is fair,” notes BlackRock.

Many QQQ components are using technology to disrupt the industries they are in. These companies use innovation and technology to create competitive advantages across multiple sectors and industries beyond tech. The coronavirus pandemic also highlights opportunities with tech stocks and QQQ. Fortunately, it looks as though earnings growth will support the case for QQQ and the growth factor at large.

“Tech stocks have led the charge, with the Nasdaq 100 Index up over 40%. We don’t see a disconnect – because of the nature and visibility of this shock,” adds BlackRock. “We view it as akin to a natural disaster followed by a rapid activity restart, and see the cumulative economic shortfall as just a fraction of that seen after the global financial crisis – an outlook markets have been quick to price in. Valuations do not look obviously stretched, as our estimate of the compensation for taking equity risk shows. The flip side: The eventual restart may not give stocks as much of a lift as past recoveries. Earnings growth will likely need to be the primary driver of returns given today’s valuations, and we see potential for a strong earnings rebound ahead.”

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The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.

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