TQQQ Is A High-Risk Low-Reward Investment (NASDAQ:TQQQ) (2024)

There is one ETF that has generated a staggering 57X return over the past decade, hypothetically turning a $10K investment into over a half-million dollars. It is the ProShares 3X leveraged Nasdaq 100 ETF (NASDAQ:TQQQ). With $9B assets under management, TQQQ is by far the largest leveraged ETF on the market. Quite frankly, it has become a speculative juggernaut that may be causing many investors to fail to see its downside risk.

As you can see below, its AUM has recently climbed to an extremely high level:

Data by YCharts

The second-largest leveraged ETF on the market is the other ProShares 2X leveraged Nasdaq 100 ETF (QLD) at an AUM of $3B. Combined, these funds have total Nasdaq exposure of $33B, given their AUM and leveraged levels.

Considering there are many other leveraged ETFs with similar Nasdaq/Tech exposure, it is likely the case that they can have a material impact on markets. When stocks are rising, they must buy at 2-3X the pace which causes increased buying pressure. When stocks are falling, they must sell at 2-3X the pace which causes added selling pressure.

Whether or not leveraged ETFs are a systemic risk to markets, they are extremely risky to buy and hold. Many investors may not see this, considering TQQQ has only gone up over the long-run. However, when a larger crash occurs, the fund may find itself seeing 95%+ losses.

The Importance of Leverage Decay

TQQQ is up 45% on the year, while the Nasdaq 100 ETF (QQQ) is up 29%. Those that would expect TQQQ to be up 87% (3X 29%) would be wrong due to the extreme leverage decay TQQQ faces. When volatility is higher, TQQQ tends to underperform. Hence, during the highly volatile March decline, QQQ fell about 28%, while TQQQ declined 66%.

This is an underlying issue with leveraged ETFs that rebalance daily. If the market falls 5% and then rises 5% the next day, the net result would be a 0.25% decline. However, with a 3X leveraged ETF like TQQQ, the 15% drop and subsequent 15% rise would result in a 2.25% decline, which is 9X larger than the non-levered decline.

This may sound a bit technical, but it is important to remember as it is a hidden risk in leveraged ETFs. The bottom line is that, when volatility is higher, leveraged ETFs tend to drag more. Volatility is higher during corrections and crashes. This is why TQQQ has actually hardly outperformed QQQ this year despite seeing much larger daily changes and declines.

Inverse leveraged ETFs have almost all lost 99.9%+ of their value since inception, while many bullish ETFs are positive. However, if a large 40-50%+ crash occurs, it is likely many will see almost all of their value evaporate. Remember, a 50% decline requires a subsequent 100% return to breakeven, while a 50% rise requires a 33% loss to breakeven. Eventually, TQQQ will likely see such a loss that it never fully recovers from.

TQQQ Is the Cornerstone of Irrational Exuberance

TQQQ has seen significant inflows this year and has become very popular among many. As you can see below, there was a huge increase in Google search volume for the term "TQQQ" during the March decline:

(Google Trends)

The rise in search volume has lasted since March and saw another spike in September during the correction. Clearly, TQQQ is a major target of dip-buyers. That said, recent data suggest search volume for "TQQQ" is rapidly declining, a possible signal that speculative fervor in Nasdaq 100 companies is peaking.

In reality, the Nasdaq 100 is comprised of about five companies, Apple (AAPL), Microsoft (MSFT), Amazon (AMZN), Facebook (FB), and Google (GOOG) (GOOGL). Collectively, these five companies make up 46% of the entire Nasdaq 100. As you can see below, the price-to-sales valuations of most of these companies are at high levels by historical standards:

Data by YCharts

High historical valuations are most prominent for Apple, Amazon, and Microsoft, which collectively make up 39% of the Nasdaq 100 today. Interestingly, the revenue growth rates of these three companies have declined over the past decade, while their valuations are at all-time highs. Normally, high valuations come with high revenue growth.

Even more, the House antitrust committee recently released a report on Big Tech that claimed all of these companies but Microsoft enjoy "monopoly power" and should be broken up. By definition, 'monopoly power' suggests these companies get excess profits from their market share that they would not enjoy if broken up. Thus, the credible threat to create legalization that will break up and/or create significant new regulations on these companies should result in a decline in profits and therefore equity prices. However, none of these stocks have reacted to the news as of yet.

While many of these "Big Tech" companies are decent companies that create products most of us enjoy, their stock prices are not rational. They are trading at high valuations with low growth. COVID-19 is causing a general economic slowdown. Though the recession has yet to impact Tech giants, I believe it will eventually as the "B2B" economy slows. Finally, the credible threat of antitrust legislation on these firms is enough to catalyze a decline in equity prices.

The Bottom Line

Overall, I firmly believe investors should avoid TQQQ. There has been a surge in buyers since March which has lifted its AUM to a staggeringly high level. TQQQ is a target of dip-buyers, which has likely caused many to achieve stellar returns. However, with all of the negative catalysts surrounding Big Tech companies, the possibility of a dip that does not result in a bounce is very high. This could easily cause TQQQ to lose 75% or more of its value due to leverage volatility decay.

Even TQQQ's performance this year is nothing to write home about. The fund is up a solid 45%, but it experienced a 66% decline in a matter of weeks. Its overall performance is not much better than the Nasdaq 100 at 29%, which benefits from having a third of the volatility. Put simply, TQQQ is a high-risk low-reward ETF that is likely to deliver startlingly negative returns over the next year.

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