Commentary: A Better Way to Trade Tech

By David Henry

While Wall Street grapples with the pain of the bear market, one of its new-fangled securities stands out as a winner. Cubes, as they are called, are trading in huge volumes averaging 65 million shares a day. Some days, volume spikes over 100 million shares. They trade more than any stock but Cisco Systems Inc. (CSCO )

The shares, also known as Qs for their ticker symbol, QQQ, are issued by a trust that holds the stocks of the Nasdaq-100 index. First listed Mar. 10, 1999, on the American Stock Exchange, they trade throughout the day, unlike mutual funds. Their price moves almost tick for tick with the index. With 70% of the index in tech stocks, Cubes are the easiest way in and out of the sector. Some investors believe the strong volume is signaling a new bull market in tech. But that's wishful thinking. Cubes' popularity is rising because bears and bulls alike find them a useful trading tool.

"COUNTERINTUITIVE." Cubes' success stands out against the 61% loss the Nasdaq 100 has suffered since March, 2000. Historically, trading slows a few months after markets peak in price. But Cubes are trading twice as much as at the peak 16 months ago.

What is happening "is counterintuitive," acknowledges Amex President Peter Quick. People usually trade less after prices fall because they lose confidence in their ability to pick winners, says Meir Statman, a behavioral finance professor at Santa Clara University. The effect lingers. The 1987 stock market plunge depressed volume until 1992, two years after major indexes recovered.

To satisfy higher demand, the trust issues additional Cubes in exchange for stocks of the Nasdaq 100 companies. The QQQ trust had 532 million shares outstanding as of July 2, up from 134 million a year ago and a tiny 0.3 million when trading began. In 28 months of business, trust assets have grown to $24 billion.

Some say that individual investors are bullishly flocking to the Cubes. John L. Jacobs, Nasdaq's senior vice-president and administrator of the QQQ trust, notes that the trust sends out 2,250 prospectuses a day to investors who have bought for the first time. He adds that filings to the Securities & Exchange Commission by institutions indicate that individuals own 72% of Cubes. Says Jacobs: "This is a buy-and-hold product."

But Jacob's image of individual investors stashing away Cubes is off the mark. For one, at current trading volumes, the trust's outstanding shares change hands every eight days. "It is pure speculation when you're trading at that rate," says John C. Bogle, founder of Vanguard Group. Cisco shares turn over every 111 days. Institutions, not individual investors, dominate Cubes trading, say dealers who see the orders.

MICROSOFT PROXY. Trading by institutional investors suggests nothing about where tech stocks are headed. Some sell Cubes short to bet that tech stocks will go lower. Others sell them short to cut the risk of the tech stocks they're holding. And others buy Cubes to hedge against a broad tech rally while they short specific stocks.

"They've become a playground for professionals," says Steven C. Leuthold of Leuthold Weeden Capital Management. Take June 28. Traders piled into Cubes when trading in Microsoft Corp. (MSFT ) was halted after a court ruling. Microsoft shares account for 11% of the Nasdaq, and the betting was that when they resumed trading, the stock would jump, pushing up the price of the Cubes.

As Cubes trade more, institutions see more ways to use them. They have become so liquid that mutual-fund managers are increasingly substituting them for cash they keep on hand to meet redemptions, says Avi Nachmany, research director at Strategic Insight Mutual Fund Research & Consulting.

Cubes go a long way helping investors big and small trade tech stocks. Now, if only they would forecast a rally.

Henry covers the markets.

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