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QQQ: Why Another 83% Tech Crash Should Not Be Ruled Out
Jan. 03, 2025 12:36 PM ETInvesco QQQ Trust ETF (QQQ), NDX
Stuart Allsopp profile picture
Stuart Allsopp
6.64K Followers

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Summary
The 83% crash in the tech sector from 2000 to 2002 was the result of a negative
shift in investor mindsets following a period of "buy at any price".
All it would take for a similar size decline today would be for investors to
require a similarly large equity risk premium as they did in 2012.
Market breadth and bullish sentiment are alarmingly similar to the 2000 peak,
indicating the potential for a significant market correction.
Put options are a low-cost, high-reward strategy to hedge against a potential large
drop in QQQ.
Businessman

D-Keine

In my last article on the Invesco QQQ Trust (NASDAQ:QQQ) in January, I warned of a

parabolic rise in tech stocks before the bubble eventually bursts. After rising a
further 25%, the risks are now overwhelmingly tilted to the downside. As is the
case during most bubbles, increasing stock prices have led to an increase in
optimism, and it will sound ridiculous to most readers to even contemplate another
major decline. Such is the nature of market bubbles and subsequent crashes. If they
were widely anticipated, they wouldn't happen. As I will explain below, all it
would take for another 83% decline in the QQQ, as occurred from the 2000 peak to
the 2002 trough, would be for investors to require a similarly large equity risk
premium as they did in 2012. To be clear, I do not expect such a large decline, but
if it seems impossible, you may be suffering from a lack of imagination.

Chart of QQQ from tech bubble peak

QQQ ETF (Bloomberg)

What Caused The Last 83% Decline In The QQQ?

The 83% decline from the 2000 peak did not result from some unpredictable economic
crisis or deflationary event. During this period, the economy grew at a healthy
pace of 4% annually in nominal terms, while US corporate profits rose by 7%
annually. Meanwhile, both nominal and real interest rates fell significantly. In
real terms, the decline was larger than that seen during the Great Depression, yet
there was no economic crisis to speak of. The reason for the decline was not that
the earnings of the companies that dominated the index suffered - for three of the
big 4 stocks at the time - Microsoft (MSFT), Cisco (CSCO) and Oracle (ORCL) - both
sales and earnings actually rose from 2000 to 2002. Rather, investors simply paid
too high a price for these companies' sales and earnings, often using margin debt,
in the belief that large quality companies would continue rising indefinitely. When
prices started to fall, these investors were either forced to or chose to sell
after accumulating losses, which set in motion a self-reinforcing cycle of market
declines.

All It Would Take For Another 83% Decline Is A Return To Elevated Risk Premiums
The Nasdaq 100 currently trades at 43x free cash flow and 43x earnings excluding
extraordinary items. The free cash flow multiple rises to 52x when we factor in the
very real cost of stock-based compensation. If we use enterprise value as the
numerator rather than market cap, the multiple rises to 54x. The following table
shows the size of the market decline required for the Nasdaq 100 to trade at the
levels seen at cyclical market lows seen over the past 12 years. Note that none of
these market lows were the result of any economic crisis. A return to the free cash
flow multiples seen at the 2012 lows would require a staggering 78% market decline.

Market Low EV/FCF ex-SBC Required % Decline In QQQ

Jun-22 27 50
Dec-18 20 63
Feb-16 17 69
Jun-12 12 78
But wait, it gets worse. At the 2012 lows, the economy was growing at over 4% in
nominal terms, while interest rates were near zero. If investors anticipated long
term NDX sales and free cash flow growth of 4% with an 8% free cash flow yield,
with interest rates of zero, the forward-looking equity risk premium amounted to
12%. A similarly large equity risk premium today, with nominal GDP growth and
interest rates both around the same level of around 4.5% would require the Nasdaq
100 to trade with a free cash flow yield of 12%, or a multiple of just over 8x.
This would require an 85% market decline.

A similar sized decline can be arrived at by looking at how high the dividend yield
would have to rise to for the NDX to achieve historical average returns of 10%. If
dividends were to grow at 4% annually in line with trend nominal GDP growth, the
dividend yield would have to rise to 6% from just 0.7% today, which would require
an 88% decline in the index. Even if companies to somehow pay out all of their free
cash flow in the form of dividends and buybacks, the free cash flow yield of 1.9%
would have to rise to 6%, requiring a decline of around 70%.

Collapsing Sales Growth And Risks To Profit Margins

To be clear, I do not expect to see such a large decline, but my point is that the
risk-reward outlook is extremely negative. The idea that the Nasdaq 100 should
perpetually trade at high multiples due to its history of strong growth ignores the
tendency for the largest companies in the market to experience far slower long-term
growth relative to the rest of the market (see '10 Charts That Show The
Unprecedented Scale Of The Magnificent 7 Bubble'). When measured from the peak of
2007, real sales and operating profits for the top 100 US companies have grown by
just 0.5% annually.

OEX 100 Real Sales Growth

OEX 100 Real Sales Per Share (Bloomberg)

The bullish arguments also ignore the tendency for profit margins to mean revert
over time and the risks posed by the extremely low level of US savings. As I argued
in 'Sell The Trump Rally Before The Profit Bubble Bursts', US corporate profits
have risen despite a collapse in US savings, but America First policies threaten to
reverse this dynamic, particularly with Trump's base increasingly opposed to legal
immigration. The chart below shows how Nasdaq companies have increased their share
of total US profits and savings over recent years. A significant decline in
earnings should not be ruled out over the coming years.

Nasdaq profits vs economy

Bloomberg, BEA

Breadth And Sentiment Echo 2000

The 2000 market bubble peak was characterized by extreme weakness in market
breadth, with a small number of mega cap tech finally giving way and joining the
bear market that had already begun in the average stock. While not quite as extreme
today, the NDX outperformance relative to the median stock once again at worrying
levels, while the number of stocks hitting 52-week lows continues to exceed the
number hitting 52-week highs for the S&P500.

Ratio of NDX 100 over Equally Weighted S&P500

Ratio of NDX 100 over Equally Weighted S&P500 (Bloomberg)

Meanwhile, sentiment is extremely bullish. According to the Conference Board's

consumer confidence survey, the gap between respondents seeing stocks higher over
the next 12 months versus lower is the highest level on record, eclipsing the
second-highest reading which occurred just before the peak of the dot.com bubble.

Expectations of Stock Increases vs Stock Decreases Over Next 12 Months

Expectations of Stock Increases vs Stock Decreases Over Next 12 Months (Bloomberg,
Conference Board)

How To Play It
One of the main differences between now and the 2000 peak is the level of implied
volatility, which makes buying put options today very attractive. It now costs just
3% to hedge against a 23% drop in the QQQ to $400 over the next 24 months. I am
more than willing to take on such a low risk, high reward trade, and anyone who
wishes to remain long QQQ may find that capping losses to 23% over the next 2 years
for just 3% of their position will allow them to sleep much better.

Price of QQQ Options With A Strike Of 400 Expiring On December 18, 2026
Price of QQQ Options With A Strike Of 400 Expiring On December 18, 2026 (Bloomberg)

Summary
The 83% decline in the QQQ from the 2000 peak started from the kind of extreme
overvaluation and overoptimism we see today. A similar sized decline would not
necessarily require an economic crisis, just a closing of the extremely wide gap
between the returns that the market is priced for and the returns that investors
have historically required even during periods of stable growth. Put options offer
a great opportunity for speculators looking to bet on a low cost, high reward
event, and offer a cheap way for bulls to protect their recent gains.

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This article was written by

Stuart Allsopp profile picture

Stuart Allsopp
6.64K Followers
I am a full-time investor and owner of Icon Economics - a macro research company
focussed on providing contrarian investment ideas across FX, Equities, and Fixed
Income based on Austrian economic theory. Formerly Head of Financial Markets at
Fitch Solutions, I have 15 years of experience investing and analysing Asian and
Global markets.
Show more
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Analyst’s Disclosure: I/we have a beneficial short position in the shares of QQQ,
NDX either through stock ownership, options, or other derivatives. I wrote this
article myself, and it expresses my own opinions. I am not receiving compensation
for it (other than from Seeking Alpha). I have no business relationship with any
company whose stock is mentioned in this article.

Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No

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for a particular investor. Any views or opinions expressed above may not reflect
those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities
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About This Article

?
ETF Covered
QQQ
Analyst's rating at publication
Strong Sell
Analyst's rating history
Chart

Line chart with 2 lines.

View as data table, Chart
The chart has 1 X axis displaying Time. Data ranges from 2024-01-02 00:00:00 to
2025-01-02 00:00:00.
The chart has 1 Y axis displaying values. Data ranges from 396.28 to 538.17.
End of interactive chart.
About QQQ ETF
Symbol Last Price % Chg
QQQ
519.02 1.72%
1D
5D
1M
6M
1Y
5Y
10Y
Chart
Combination chart with 2 data series.
View as data table, Chart
The chart has 1 X axis displaying Time. Data ranges from 2024-12-30 09:30:00 to
2025-01-03 14:00:00.
The chart has 1 Y axis displaying values. Data ranges from 506.4 to 519.17.
End of interactive chart.
Expense Ratio
0.20%
Div Frequency
Quarterly
Div Rate
$2.85
Yield
0.56%
Assets (AUM)
$318.25B
QQQ Ratings
SA Analysts
Hold
Rating: Hold2.72
Wall Street
Not Covered
Rating: Not Covered
-
Rating: Not Covered
Quant
Buy
Rating: Buy4.34
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?
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