3 Reasons the PowerShares QQQ ETF (QQQ) Could Fall

Will these reasons lead you to sell, hang on, or buy?

Aug 26, 2014 at 9:16AM

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Photo: Flickr user Luis Villa del Campo.

If you don't have the time or expertise to carefully select individual stocks in which to invest, consider exchange-traded funds (ETFs) instead. One to consider is the PowerShares QQQ ETF (NASDAQ:QQQ). It has a lot to recommend it, but there are also some reasons why it could shrink in value.

I've covered some reasons it could surge in another article, so let's review some reasons why it might drop in value. First, though, a review of its basics.

In a nutshell

The PowerShares QQQ ETF tracks the Nasdaq 100 Index, which is made up of 100 of the biggest stocks in the Nasdaq Stock Market. It's technology-heavy, featuring industries such as telecommunications, retail, biotechnology, and computer hardware and software.

Compared to many other major technology-focused ETFs, such as the First Trust Technology AlphaDEX ETF, this one is bigger, charges less in fees, and has a more impressive performance record. Its expense ratio, or annual fee, is a very low 0.2%, comparing favorably with many peers.

Why the PowerShares QQQ ETF could drop

If you're thinking of investing in the PowerShares QQQ ETF, here are a few risks to consider

  1. It's weighted far more heavily in some stocks than others, giving them huge influence on its performance.
  2. Some are suggesting that it's due for a fall because it has risen so much.
  3. Consumer discretionary companies might experience a downturn.

It's stuffed with Apple filling

While some indexes weight components equally or based on financial metrics like revenue, the Nasdaq 100 Index, like many other indexes, is weighted by market capitalization. In such indexes, companies with hefty market caps will have much more influence than smaller counterparts. In the PowerShares QQQ ETF, for example, shares of Apple (NASDAQ:AAPL) make up more than 13% of overall value. So to a meaningful degree, Apple's future will dictate the ETF's future.

Fortunately, many see much more growth ahead for Apple. Still, it isn't firing on all cylinders. Its iPad sales have been slipping, and while emerging and developing markets represent a huge growth opportunity for technology companies, Apple's market share there has been shrinking in recent years. Remember, too, that Apple occasionally debuts flops. Its upcoming iPhone 6 is highly anticipated, as are the iWatch and other offerings. If these launches don't go as well as expected, the stock could take a hit.

It might be time for a downturn

Another reason the ETF could fall in value is actually based on something positive: its performance in recent years. From 2009 to 2013, the ETF notched annual gains of 55%, 20%, 3%, 18%, and 37%, successively. So far this year, it's up almost 14%. Therefore some suggest that it's due for a drop. That's a common way of thinking, and it even seems reasonable. But the prices of securities are tied to factors such as economic performance, valuation, and investor psychology -- not to the sequences of numbers. 

Instead of worrying about recent performance, let's take a closer look this ETF's valuation. The price-to-earnings (P/E) ratio of its underlying index, the Nasdaq 100, was recently 23.1, up from 20.3 a year ago. For a tech-heavy investment, that's not exactly sky-high, but it's not compellingly low, either. That's also higher than the recent 19.2 P/E ratio for the S&P 500. These numbers suggest that the Nasdaq 100 index is somewhat overvalued -- and therefore that the ETF might be due for a pullback.

Consumer discretionary companies might experience a downturn

Another risk for this ETF is that one of its major sectors could encounter a rough patch. Consider, for example, that it recently had about 18.6% of its assets in consumer discretionary companies. Unlike consumer staples such as soap, medicine and food, discretionary goods and services suffer declining demand when consumers need to tighten their budgets. Imagine how some of the ETF's holdings might be affected by another recession and high unemployment. Starbucks may see a dip in sales as folks cut back on expensive treats. Priceline Group and Marriott will take a hit if consumers cut back on vacation travel (not to mention business travel). Businesses won't buy as much from Staples, and cable companies such as Comcast might see customers cutting cords. Things don't always play out as expected -- for example, Amazon.com fared well in the last recession -- but an economic downturn would hurt many of this ETF's holdings.

Ponder these reasons this ETF might fall -- but check out some reasons it might rise, too.

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Longtime Fool specialist Selena Maranjian, whom you can follow on Twitter, owns shares of Apple, Priceline Group, and Starbucks. The Motley Fool recommends Apple, Priceline Group, and Starbucks. The Motley Fool owns shares of Apple, Amazon.com, Priceline Group, Staples, and Starbucks. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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