As has been widely noted, mega-cap growth equities are supporting a significant portion of equity market upside through the first four months of 2023. Not surprisingly, that’s sparking concern about market breadth, but the quality traits of this segment should not be overlooked.
Investors looking to embrace those characteristics have allies with various exchange traded funds, including the Invesco QQQ Trust (QQQ ) and the Invesco NASDAQ 100 ETF (QQQM ). Those ETFs, which have identical lineups, are homes to some of this year’s best-performing stocks. Alone, that’s worth bragging about, but there’s more to the story.
While many QQQ and QQQM member firms are viewed through the lens of growth/momentum, the reality is that many also exhibit indelible quality traits — something that’s been on display amid a recent spate of earnings surprises.
“Quality companies are often better positioned to endure worsening economic conditions. In general, quality tends to perform best during economic slowdowns and contractions. When we look at the two largest drawdowns since the turn of the century, higher quality companies not only outperformed their lower quality peers, but also broad equity markets,” according to BlackRock.
Indeed, there have been periods in which unprofitable or “junk” companies have seen their shares rapidly appreciate, but profitability is something that never goes out of style — nor does a company’s ability to provide predictable earnings visibility and foster strong balance sheets. Many QQQ and QQQM components frequently boast these traits.
“While there are varying definitions of quality, in a time of financial stress, we can define quality companies as those that have less exposure to interest rate risk—or low leverage, and companies that generate consistent, less volatile earnings over time,” added BlackRock.
Speaking of balance sheet strength, that is a hallmark of many QQQ and QQQM holdings, particularly the ETFs’ marquee components hailing from the technology sector. Balance sheet sturdiness doesn’t provide full insulation amid macroeconomic headwinds or broader market declines, but the trait can serve the objective of damping volatility and reducing downside risk.
“We believe companies on stronger footing will continue to outperform, with March marking an extended stretch of time (13 consecutive trading days) in which strong balance sheets outperformed weaker ones by a total of 8.41pp. As macro drivers evolve, we advocate investors focus on what they can control and where they have visibility into future earnings and cash flows,” noted Goldman Sachs Asset Management.
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