Busting the Faang Oligarchy Is Stimulus Active Funds Could Savor
(Bloomberg) -- Frenzied retail buying catapults equity benchmarks to records. A handful of mega-companies dominate, drawing daily warnings about nosebleed valuations. Suddenly a rotation takes hold, reviving left-behind industries while crushing the broader market.
The 2021 setup in stocks? Maybe. They are the same circumstances investors faced two decades ago, when the popping of the dot-com bubble unleashed a protracted swoon in the S&P 500 and Nasdaq 100. A less-discussed aspect of that episode is that it became a good time for stock-picking hedge funds, whose ability to navigate three years of volatility could be a blueprint for success today.
While rotations have fizzled in recent months, industry leadership is being challenged anew, with Democratic victories in Senate runoffs boosting bets on economic stimulus even as rising rates hinder richly valued technology companies. Small-cap shares surged almost 6% in the past week, beating the Nasdaq 100 by the most in two months, and a version of the S&P 500 that strips out market-value bias and loosens the grip of the Faang block at one point rose four times as much as the cap-weighted gauge.
“If you’re just leaning a little bit into the right sector in the coming months, you’re going to be able to add significant value over passive,” Rich Weiss, chief investment officer of multi-asset strategies at American Century Investments, said by phone. “There is a big turn coming and that woos active managers to get in front of it.”
Improving market breadth has boded well for stock pickers in the past, regardless of the market’s overall direction. Between 2000 and 2002, when the S&P 500 tumbled at least 10% in three straight years, speculative money managers that make bullish and bearish bets did well by their clients. The industry delivered gains in the first two years -- up 9% in 2000 and 0.4% in 2001, according to data compiled by Hedge Fund Research. In 2002, when their returns turned negative, the 4.7% loss was only one fifth of the market’s.
Short positions helped hedge funds cushion the downside while the market was in free-fall. Also in their favor was an expanding pool of winners. While the S&P 500 tumbled in 2000, its equal-weighted version climbed almost 8%.
Among long-only funds, broad gains also tend to bolster returns. Take 2009, the only year when the average stock did better than in 2000. That year, only 40.7% of equity funds trailed the benchmark, a decade low, according to data compiled by S&P Dow Jones Indices.
A market rally that is broader than 10 or 15 stocks “is beneficial to managers,” said Brent Schutte, chief investment strategist at Northwestern Mutual Wealth Management. “No active manager probably overweights all those stocks as much as they need to in that type of environment. As it broadens out, it opens up more performance opportunities.”
Of course, what’s happening now doesn’t match the events of 20 years ago in terms of severity. Back then, tech was at the center of an epic meltdown driven by an unwinding of investment often in unprofitable businesses. Today the country is recovering from a pandemic-induced recession. Rather than contracting like in 2000, computer and software company profits are defying a broad decline and expanding.
Still, as then, there is the possibility that a handful of market behemoths loosening their grip. As Senate runoffs in Georgia stoked expectations that Democrats may step up stimulus and tighten regulation, four of the Faangs fell, wiping out $75 billion in total value. Meanwhile, the KBW Bank Index surged almost 9% while energy shares in the S&P 500 jumped 9.3% as a group.
While one week is hardly evidence of durable trend, it at least gives hope to stock pickers tyrannized by the stay-at-home trade. Driven by the rotation, the S&P 500 equal-weight index climbed 2.9%, versus a gain of 1.8% in the traditional measure.
Last year was a poor one for active investing as only 37% of S&P 500 stocks did better than the broad gauge, the lowest proportion since 1999, data compiled by Bank of America Corp. showed. Less than 20% of large-cap core funds outperformed their benchmark, down from 28% a year earlier.
A swift rotation out of tech megacaps would be welcome news for active managers who have mostly failed to own enough Faang stocks to keep up with benchmarks. Among roughly 200 funds benchmarked to the S&P 500 that have at least $500 million in assets, those with at least one-fifth of their money in Facebook Inc., Amazon.com Inc., Apple Inc., Microsoft Corp. and Alphabet Inc. have returned 24% on average over the past 12 months. That dwarfs a 17% gain for those that have no stake.
Gains from value shares and small caps may prove a tailwind for active funds by broadening the number of potential winning stocks following a year when half the S&P 500’s advance was attributable to five tech megacaps. Less than a third of the companies in the S&P 1500 Composite outperformed the S&P 500 on a 12-month trailing basis through November, according to data compiled by Leuthold Group. That proportion is likely to double in the coming year, the firm’s chief investment officer, Doug Ramsey, recently wrote.
“Broad market outperformance isn’t always synonymous with big market gains, but it has active managers cheering,” Ramsey said in an email Wednesday. “The percentage of outperforming stocks is still very low, and I still expect it to explode.”
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