Sunday, July 6, 2008

Should the NASDAQ be considered a tech index?

Many bloggers and stock market commentators often refer to the NASDAQ as "tech-heavy" and it is often treated as a proxy for tech stocks in general.

In order to trade the NASDAQ many investors use the PowerShares QQQ Trust ETF (QQQQ). Those who are seeking a little more juice may use the ProShares Ultra QQQ ETF (QLD) which is intended to deliver twice the performance of QQQQ on a daily basis.

In any case, we know that the NASDAQ 100 and these ETFs contain stocks that fall into more sectors than just tech. Specifically, the NASDAQ 100 index is limited to the 100 largest non-financial stocks listed on the NASDAQ Stock Market and includes sectors such as media, health care, consumer services, etc.

As an alternative to QQQQ and QLD, those who wish to trade a pure technology stock index can use the ProShares Ultra Technology ETF (ROM). This ETF tracks the Dow Jones U.S. Technology index which is comprised of 194 tech stocks ranging from mega-cap (Microsoft, Oracle, etc.) to small-cap (LSI, Interwoven, etc.)

Interestingly, ROM does not include Amazon which is widely considered to be a tech stock though it should more accurately be thought of as a retailer that uses technology as a potent differentiator. ROM also does not include telecom service stocks though it does contain all the semiconductor stocks that are also held by QQQQ and QLD.

Tech stocks in the NASDAQ 100 --

In order to demonstrate how tech-focused the NASDAQ 100 actually is, I compared the stocks that make up QLD to the holdings of ROM. The ETFs have the following 34 stocks in common:

ADOBE SYSTEMS INC COM STK
AKAMAI TECHNOLOGIES COM
ALTERA CORP COM STK
APPLE INC COM STK NPV
APPLIED MTRLS USD0.01
AUTODESK INC COM STK NPV
BROADCOM CORP CLASS'A'COM
CA INC COM STK USD0.10
CADENCE DESIGN SYSTEMS
CISCO SYSTEMS INC COM STK
CITRIX SYSTEMS USD0.001
COGNIZANT TECH USD0.01
DELL INC COM STK USD0.01
GOOGLE INC COM STK
INTEL CORP COM STK
INTUIT INC COM STK
JUNIPER NETWORKS COM STK
KLA TENCOR CORP COM STK
LAM RESEARCH CORP COM STK
LINEAR TECHNOLOGY CORP
MICROCHIP TECHNOLOGY COM
MICROSOFT USD0.000125
NETAPP INC COM STK NPV
NVIDIA USD0.001
ORACLE CORP COM STK
QUALCOMM USD0.0001
SANDISK CORP COM STK
SUN MICROSYSTEMS INC COM
SYMANTEC USD0.01
VERISIGN COM STK USD0.001
XILINX USD0.01
YAHOO INC COM STK
CHECK POINT SFTWR
MARVELL TECH GROUP COM

This implies that the NASDAQ 100, and by extension QQQQ and QLD, is comprised of approximately one third tech stocks. It is true that this is probably an overweight allocation in terms of the composition of the entire stock market. Still, it illustrates that it is somewhat of a misnomer to consider the NASDAQ 100 as a proxy for the technology industry. After all, some of the other stocks on the NASDAQ 100 include Bed, Bath and Beyond, Hansen Natural, Sears Holdings and others that hardly fall into the tech category.

For those who are looking within the ProShares offerings for pure sector funds, it seems more reasonable, therefore, to pick ROM.

Relative performance --

It is often said that perception is everything in the stock market. It is worth investigating whether QLD trades in a similar manner to ROM despite QLD's very different makeup.

The chart below compares closing prices of QLD and ROM since ROM began trading in February 2007.


It is clear that the two ETFs for the most part track each other quite closely. This tends to support the idea that investors consider both ETFs to be quite similar. Whether or not the NASDAQ 100 is a tech index it certainly seems to trade like one.

The next chart looks more closely at the differences in performance. It shows that QLD tends to outperform ROM by several percentage points during bullish periods. During bearish periods, especially during the last couple of months, QLD has managed to hold its value somewhat better than ROM.

It is possible that the more limited daily volume in shares traded in ROM is a factor in its under-performance with respect to QLD. As I discussed in a prior post ("ProShares ETFs - why trading volume makes a difference"), the smaller the trading volume, the more erratic the tracking of the underlying index. ROM falls about midway down the list of ProShares ETFs in terms of average daily trading volume and this may help account for the ETF's inability to match QLD's performance during bullish periods.

Conclusion --

If an ETF investor is interested in allocating a portion of a portfolio to tech stocks it appears that, based on performance, the better choice is actually an ETF that tracks an index based on the NASDAQ 100. If an investor is further interested in ProShares double long ETFs, it appears that the best choice is QLD.

Of course, in the market downturn we are currently experiencing, all the long or double long ETFs are suffering. The fact that QLD is holding up somewhat better than ROM, however, is probably due to QLD's more diversified holdings.

Disclosure: at time of writing, author doesn't own any of the ETFs or stocks mentioned in this article.



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