Digging Into Contradictions in Large-Cap Tech

DIGGING INTO THE CURRENT CONTRADICTIONS OF THE LARGE-CAP TECH SECTOR

I thought this weekend would be an appropriate time to do a little digging into the tech sector and some of its recent anomalies, given that the QQQQ's basically closed on Friday dead flat for the year (which is quite an accomplishment given their performance during periods of July and August).

First, let's start with just a little primer on what the QQQQ's are exactly. Many folks misunderstand the QQQQ's..they are not an ETF reflecting the entirety of the NASDAQ stock universe. They are formally known as the NASDAQ-100 Index Tracking Stock, which includes 100 of the largest domestic and international nonfinancial companies listed on the NASDAQ Stock Market based on market capitalization. If you are a large-cap tech stock but are listed on the NYSE, such as HPQ or IBM, you are not in the QQQQ's. If you are a large-cap nonfinancial company listed on the NASDAQ you do not necessarily have to be tech-related to be in the QQQQ's index, prime examples being Starbucks (SBUX), Comcast (CMCSA), Intuitive Surgical (ISRG), Teva Pharma (TEVA), and Wynn Resorts (WYNN).

The other fact most people do not realize about the QQQQ's is how much they are weighted to the Top 10 holdings in the index, and especially to Apple (AAPL). Depending upon the day and where AAPL's stock is trading, AAPL will usually represent an 18-20% weighting in the QQQQ's and the Top 10 holdings represent about 36-42% of the weighting. Other Top 10 stocks include MSFT, QCOM, GOOG, ORCL, CSCO, INTC, TEVA, AMZN and RIMM. What is the trading implication of this? Well, certainly any active trader of the QQQQ's, QLD, or QID should always be watching where AAPL is and would be well-advised to keep a watchlist of the other nine top holdings as well. (Now, I am giving away trade secrets here but Nasdaq.com has an excellent feature which provides an updated 'heatmap" of the daily performance of each of the 100 QQQQ holdings and will even give a pre-market glance).

OK, primer over. What I really wanted to discuss is the marked imbalance in the performance between the QQQQ's themselves, several top stocks which have been doing well in 2010 and many large-cap techs which have performed miserably. The QQQQ's opened on January 4, 2010 at $46.32 and had a range this past Friday of $46.25-$46.67, which as I said is basically dead flat for the year.

However, let's take a closer look. Several of the top performers in the QQQQ's have knocked it out of the park in 2010, for a wide variety of reasons too lengthy to list here: AAPL +23%, BIDU +100%, CTSH +35%, PCLN +45%, WYNN +43% and to a lesser degree, AMZN +8%.

OK, now let's look at several of the major QQQQ's holdings which are considered "traditional" tech powerhouses but have just done extremely poorly in 2010: MSFT --23%, GOOG -24%, INTC -15%, RIMM -42%, DELL -18%, STX -42%, YHOO -19%, CSCO -14%.

And for good measure, let's look at two DOW tech stalwarts for 2010: HPQ -20% and IBM -3%. And the very important Philly Semi-Conductor Index (SOX), -14% YTD.

I do not know about you but a very clear picture emerges for me from this analysis. Specifically that a relatively low number of extremely high-performing stocks have held the QQQQ's up but the picture for large-cap tech stocks which are bellweathers for the economic recovery is not so rosy. Throw into the equation that during the last round of earnings reports there was very cautious language coming out of several large-cap techs regarding the demand and earnings situation going forward and I must admit I have some reservations here about the QQQQ's. If one were to look at the glass as half full, however, you could say that once the large-cap techs get their act together, the QQQQ's should rocket higher. Glass half-empty says a few leaders cannot hold it up alone forever. (Footnote here..every year tech earnings multiples narrow the gap versus other S&P companies, although there is still a healthy disparity).

So, do I see any trading implications here? Yes...

• I continue to believe IBM represents both a great swing-trading vehicle and a relatively "safe" long-term dividend-paying holding. Check out a chart for the wonderful swing trade opportunities. With correct entries, IBM can also be a great way to play covered calls.
  
• As said above, I am very cautious on the QQQQ's here. A move above $47.80 could be a good breakout opportunity. Deep support is at the $42.00 area. Anything in between is really a swing trade dependent on the overall market performance of any specific day, week or month.
  
• Trade AAPL, GOOG, and AMZN cautiously and at your own risk. AAPL especially could be up or down 30 points in the next month, dependent on the market and specific AAPL news. Many analysts currently have targets north of $300. I definitely prefer call or put spreads when playing AAPL versus common stock. Even more so than IBM, AAPL's juicy option premiums make it a great covered call candidate (and also great for a variety of other options strategies), if you can stomach the downswings and willing to hold for the long haul.
  
• RIMM announces earnings after the close on 9/16/10. It is always extremely volatile around earnings and usually a great candidate for an option put/call straddle. Whispers on earnings have indicated a slight beat and with the stock having been so crushed with so much negative news, a "win" this time would not surprise me at all.
  
• Keep an eye on those large-cap tech bellwethers… I believe they, along with the financials, hold a major key to the overall health of this stock market.