Great Reopening Trade Is Back as Hedge Funds Add Stock Longs
(Bloomberg) -- With a helping hand from the Federal Reserve, the great reopening trade is staging a return on Wall Street as money managers bet the U.S. consumer won’t be cowed by the delta-virus variant.
Equities tied to the economic cycle including value and financials are rebounding, while investors just sank $5.5 billion into the largest ETF tracking the Russell 2000 Index of small-cap companies -- the most in five years.
Last week’s hawkish U.S. central bank meeting is powering rate-sensitive trades as inflation-adjusted yields hit the highest since June.
JPMorgan Chase & Co. data shows hedge funds are re-building exposure to stocks hitched to the expansion, with plenty of ammo to extend longs anew. Meanwhile, an index of economic-data surprises is rebounding from recent lows, suggesting supply-side woes have yet to derail the recovery in investment and consumption as much as feared.
“The gradual shift in central bank policy reflects optimism over economic growth, rather than worries over inflation,” UBS Group AG’s global wealth management team led by Mark Haefele wrote in a Monday note. “Rather than ending the equity rally, we expect the rise in yields to favor cyclical sectors such as financials and energy, over growth sectors such as technology.”
Bonds are selling off after the Fed signaled it will cut asset purchases from November, with a rise in long-end rates steepening the yield curve. Real rates remain negative but are above historic lows. If yields edge higher yet, it would mark a reversal from cross-asset trends over the last two quarters, when rising caution over delta-virus cases drove cash back to long-duration bets like bonds and Big Tech.
Energy and financials were the best performers on the S&P 500 last week, while bond proxies like utilities and real estate fared worst. With the 10-year Treasury yield rising above 1.5% for the first time since June, the Dow Jones Industrial Average -- which favors cyclical shares -- is outperforming the tech-heavy Nasdaq 100 in Monday trading.
Hedge funds have bought more stocks that gain from inflation and rising bond yields, while net exposure to both remains below average, JPMorgan analysts led by John Schlegel wrote in a Friday note.
The long-short ratio on a basket of shares tied to the U.S. recovery remains around the fifth percentile since January 2018, meaning that it has only been lower 5% of the time in that period, data from the prime brokerage shows.
In one view, value shares are in vogue on business-cycle optimism. In another, they are simply beneficiaries of rising rates -- prompting investors to focus more on short-term cash flows rather than the distant profits of tech darlings. By this logic, the value style still hasn’t fully priced in the recent jump in Treasury rates, per Barclays Plc.
“As the direction of travel is towards more hawkish (or less dvish) policy, we believe a grind higher in rates would be a pain trade,” a team led by Emmanuel Cau wrote in a note last week. “It would pressure some of the well owned longer duration parts of the equity market, and help rebalancing back to reflation or value plays.”
While U.S. consumer survey data shows caution, money managers are betting pent-up demand and rising household net worth will spur spending on goods and services. In the exchange-traded fund market, the $70 billion iShares Russell 2000 ETF (ticker IWM) -- a small-cap wager -- drew the biggest weekly inflow since 2016 in another sign optimism is returning to riskier strategies.
The cost of bearish options over bullish contracts -- known as skew -- has also retreated on IWM and the Financial Select Sector SPDR Fund (XLF) amid more interest in calls, according to Chris Murphy, co-head of derivatives strategy at Susquehanna.
“Although the pace of growth may have peaked, it looks set to remain elevated,” Haefele et al wrote. “Modestly higher rates look likely to impact relative sector performance, instead of dampening the equity rally overall.”
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