QQQX: Outperformance Over QQQ Should Widen

Economy Crash

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When we last wrote about Nuveen Nasdaq 100 Dynamic Overwrite Fund (NASDAQ:QQQX) and compared it with the appropriate non-option fund Invesco QQQ ETF (NASDAQ:QQQ), we did not mince words.

We rate the fund a sell at current valuations of the underlying holdings.

Source: A Slightly Better Choice To QQQ, But Don’t Expect Positive Returns

Underlying the core of our thesis, as that title reflected, was that you were getting a whisker of an advantage by buying a covered call fund. Investors that have been taught to chase yield first and ask questions later, were given a difficult lesson in how exactly this fund generates yield.

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Data by YCharts

QQQX was down 23.80% versus 24.39% for QQQ since that last article. Yes, total return did a shade better here as investors got “income” equivalent to 1.7% over 3 months. But in no universe should this be the standard goal. We look at where these funds stand today and whether you can generate any alpha from QQQX.

Current Setup

QQQX does take a different path from QQQ in terms of total holdings.

Fund characteristics

Nuveen

With 172 names in the bag, QQQX is trying to sift for value in places that QQQ, with its 102 holdings, would generally not venture.

Fund details

Invesco

That said, QQQX continues to be extremely top heavy with the first 4 companies, Apple Inc. (AAPL), Microsoft (MSFT), Alphabet Inc. (GOOG) (GOOGL) and Amazon Inc. (AMZN) accounting for over 40% of the fund.

Top 10 issuers

Nuveen

A new addition this time was the Vanguard Total Stock Market ETF (VTI). What exactly that ETF is doing inside a closed end fund benchmarking off the Nasdaq 100 index is a pure mystery. But it won’t make much difference for two reasons. The first being the percentage in the fund is minor. The second being that our passive investing bubble makes sure that you will get the same level of “ignorance is bliss” investing wherever you go in the index world. The top 6 holdings of VTI are shown below to prove our point.

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Vanguard

Overall, the fund’s holdings maintain a very heavy correlation to the expensive NASDAQ 100 and that is precisely our issue with this fund.

Options

QQQX’s option coverage has been at about 50% of the fund and the current reading was hovering right around there.

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Nuveen

This is QQQX’s way of balancing income generation while allowing for upside. Our take is that on shorter dated options, this strategy protects very poorly on the downside, while losing a good deal of the upside. Here are the numbers below for total return from April 1, 2020, to January 1, 2022.

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Data by YCharts

Below are the year-to-date total returns on NAV.

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Data by YCharts

Yes there is some protection but nowhere near enough for our tastes.

Outlook & Verdict

If that first round of bruising hurt, you better steady yourself. While a shorter term bounce would be par for the course, we are nowhere near good valuations. Investors getting excited over the lower P/E ratios are making two big errors. The first being, that the “E” is about to “evaporate”. The NORDEA model is one of the best and predicts a 40% drop in operating earnings.

An earnings recession 2023 seems increasingly likely

NORDEA

Your cheap P/E is going to look far more expensive adjusted for where earnings will actually come in. Stocks also deserve to go to at least this trend line based on our far higher than normal inflation.

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Jesse Felder-Twitter

So “growth” sectors like technology, which we have been telling you to avoid for some time now (see 3 Ways The Current Growth Bubble Is Worse Than The Dot-Com Boom), is the last place to generate covered call income. This is partially offset by very high levels of VIX and an oversold market. Tactically it becomes hard to push a bearish call here and hence we are upgrading QQQX and QQQ to neutral. Longer term, we expect extremely poor returns for both funds, but expect the outperformance of QQQX over QQQ to improve marginally over what we have seen so far. This stems from the volatility index itself as high VIX levels tend to provide more juice for option income.

Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult with a professional who knows their objectives and constraints.

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