In one of our earlier posts, we introduced the Defensive TQQQ Plus strategy as a safer way with a better risk-reward ratio to get exposure to technology stocks. Based on feedback, the name isn’t that intuitive and sounds like a mouthful, so I will call it the Defensive Tech Strategy henceforth.
If you have not read about it, or want to refresh your memory on how it works, you can visit the link below.
The Mother of Tech Crisis - The Dot Com
A thought that lingered after the prior post was whether this strategy could survive a severe tech storm. After an extended bull market where tech, in particular, has performed astoundingly well, it is only natural to worry about what is going to happen if the music stops abruptly and things start falling over a cliff. One of the ways to assess the strategy’s resilience is to put it through the Mother of All Tech Crises – The Dot Com Bubble.
In the previous study, we did not extend the backtest into the period of the dot com crisis. That is because none of the ETFs used goes that far back. But it would be insightful to know how well it stood up against one of the worst catastrophes ever to happen in the tech space.
To put things in perspective, Nasdaq ETF (Ticker: QQQ) fell more than 80% from 2000 to 2002 as the crisis unfolded. In terms of magnitude, this rivals what happened to the S&P 500 during the Great Depression in the late 1920s to 1930s. It took QQQ 14 long years to erase those losses. If you were using leverage then, the losses would have been so deep you would have gone into the zone of no return. How about the Defensive Tech Strategy? How would it fare in such a harsh environment?
Preparing the Data for the Test
Before we can do any form of backtesting, we will need to prepare the required data. The Defensive Tech Strategy uses the following ETFs:
1. ProShares UltraPro QQQ (Ticker: TQQQ)
2. SPDR Bloomberg 1-3 Month T-Bill (Ticker: BIL)
3. iShares 7-10 Year Treasury Bond ETF (Ticker: IEF)
4. SPDR Gold Trust (Ticker: GLD)
Since none of these ETFs were available at the time of the Dot Com era, we had to rely on using reasonable proxies to estimate their prices then.
For TQQQ, we make use of QQQ which has data running back to 2000. We use QQQ to estimate the daily returns of a 3x leveraged QQQ net of financing costs. Then we those returns to use to backfill TQQQ prices.
BIL can be considered to deliver cash equivalent returns. For simplicity and to be on the conservative side, we will assume it doesn’t generate anything for periods that we don’t have price data.
As for IEF and GLD, we use 10-yr Treasury Note futures and Gold futures as the proxies respectively to estimate their prices. Some differences are expected but there should not be significant deviations.
Depth of the Losses During Dot Com
With all the data in place, we can now put each of them to the test. We will see how the Defensive Tech Strategy performs against a passive buy and hold on the Nasdaq ETF QQQ as well as its 3x leveraged cousin TQQQ. I labeled the latter TQQQ (HYP) to denote that it is a hypothetical price series constructed from proxies.
Despite running on leverage through the use of TQQQ as part of its portfolio, the Defensive Tech Strategy managed to navigate through this trying period with a much lower drawdown of 44.7%. In comparison, a buy-and-hold on QQQ would have subjected you to a much bigger drawdown of 81.1%. And if you bought and held the leveraged TQQQ instead, things would be way worse as you would have lost more than 99.9% from the peak. That means if you have $100,000 at the peak, you are now left with only a pathetic $100. To break even from here, you would have to generate 100,000% in returns.
Time to Recovery from the Dot Com Losses
The next thing to look at is how long each took to fully recover the losses incurred. Defensive Tech Strategy rides it back to the peak in 4 years and 8 months which is fairly impressive. QQQ actually made that look relatively short because a buy and hold on QQQ took 14 years and 7 months, more than three times as long. But even that is mild compared to a buy and hold on TQQQ which is still far deep in the red now after more than 23 years.
Extending Comparison to GFC 2008 and the Great Inflation 2022
Since we are looking at crises, we might as well also cover the Great Financial Crisis (2008) and the recent Great Inflation period (2022) that also saw tech stocks selling off rapidly.
Note: There will be differences in the performance of the Defensive Tech Strategy if we start at different times because of rebalancing.
During each of these prominent periods of turmoil, the risk management system of the Defensive Tech Strategy mitigates damage and helps it to navigate through with lower losses than the other two. Not only that, it recovers the losses incurred much faster as well.
How Does It Look Over The Entire Period from 2000 to 2023
Now that we have seen the darkest and gloomiest times, do the years that follow more than make up for the excruciating pain endured? Knowing these will give us a more complete assessment of these strategies. So let’s examine how each of them did by extending their performance till the end of 2023.
The Defensive Tech Strategy outperformed both by a large margin delivering a CAGR of 18.6% and a volatility of 26.8%.
In contrast, a buy and hold on QQQ only pulled off with a CAGR of 7.3% and volatility of 23.5%. QQQ’s performance is starkly different from the double-digit returns most people are accustomed to from the tech sector since the Great Financial Crisis. And this is because of the drag from the burst of the dot com bubble in the earlier years. TQQQ, needless to say, is still in a horrible state. Its CAGR over the entire period is negative at -6.2%. This is the price we can pay if we mess with leverage without any form of risk management and exit plans.
In terms of risk-adjusted returns, or the Sharpe ratio, the Defensive Tech Strategy also did much better than a buy-and-hold on QQQ. Its Sharpe of 0.69 is more than twice of the latter. To put it simply, you are getting more bang for the buck.
Ending Note
Let me end this with a note of caution. The chase for higher returns will invariably involve more risk. While the technology sector holds great potential for growth and innovation, it is also one of the most volatile sectors in equities. As an investor, we should be mindful of the risks and have a plan to deal with them if the worst happens. Having a long-term horizon is good and important, but it may not be enough sometimes.
Note: All performances are measured in USD and are model performances. Trade-related expenses are factored in.
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