Earnings season is still in its early phases, but there are already reasons to believe that the current environment favors the S&P 500 over the NASDAQ. Oddly enough, some of the evidence for this can be found in the tech portion of the S&P 500 itself, as critical earnings misses from several large cap companies point to some discouraging trends for the sector as a whole. From at least a short-term perspective, this should light warning signals for those holding the PowerShares QQQ Trust ETF (QQQ) as it makes sense to consider removing exposure from assets that track the NASDAQ in favor of those that track the S&P 500, such as the SPDR S&P 500 ETF Trust (SPY). On the whole, earnings reports have held up, but the total performances seen at the sector level put the benchmark technology index in a less positive light, as broader trends are favoring other areas of the market.
Most of the evidence supporting positions in SPY over QQQ can be seen in the earnings performance so far this season. In the S&P as a whole, roughly 3/4 of the reporting companies have posted results that are better than analyst estimates. When looking at revenues in isolation, slightly more than half of those companies have passed market projections. But these numbers would be much improved without the major earnings misses that have been seen in the large-cap tech space. Examples seen so far include Intel Corp.(INTL), Advanced Micro Devices (AMD), and, more recently, Google(GOOG), and Microsoft (MSFT).
So far this year, the tech portion of the S&P 500 has posted cumulative gains of just 8.5%. This is much lower than the 18.6% gains that have been seen in the index as a whole. The tech portion of the S&P is one of only four sectors that is expected to see declining earnings growth for the second quarter, and this indicates alarming trends for assets with significant exposure to the space, such as QQQ. Events last week show a key example of these trends, with earnings at General Electric (GE) helping support price activity in SPY on a record order backlogs, and major improvements in demand for the company's jet engines and drilling equipment. At the same time, Google's stock is meeting sellers as average advertising prices are being limited by consumer shifts to mobile devices. Cost-per-click for Google offerings fell by 6% in the second quarter, largely a result of these demographic changes. To make matters worse, Microsoft posted its largest earnings miss in 10 years, as well-documented declines in PC sales and a tepid response to the Windows 8 offering erode the company's revenue prospects.
When viewed in conjunction with the earlier tech misses at AMD and INTL, a disappointing picture emerges, and this removes a good portion of the argument behind bullish tech positions in coming months. These large-cap disappointments suggest that SPY is likely to outperform relative to QQQ, given the broader trends that are seen in these weakening sectors. To date, 17 tech companies have released second quarter earnings, coming in 3.6% weaker than analyst estimates, on average. In the S&P as a whole, companies have beaten analyst estimates by 2.4%. Tech companies are expected to see profit declines of 8% for the quarter, and this trend weighs on the prospects for QQQ going forward.
Relative performance in SPY and QQQ favors non-tech companies, and the price perspective supports this trend as well. In SPY, prices are still pressuring their all-time highs with little in the way of corrective pullbacks to the downside. At this stage, it makes sense to wait for some bearish retracement before getting long again in SPY, first support buy zone can be found at 165.80.
In QQQ, prices have gapped lower after last week's big earnings misses. The bounces out of "resistance turned support" at 74.40 have been limited, however, so it is still likely we will see additional declines before real bounces can be expected. Watch support at 73.70, as this is an initial buy zone as long as support holds at those levels.
About the author:
Trade ideas are generally based on time horizons of one to six months.
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