Hedge Funds Are on Defense and Testing the Stamina of a $5 Trillion Stock Rally
(Bloomberg) -- It’s a fundamental characteristic of the rally that has restored $5 trillion of equity value in a month. As encouraging as the gains have been, they’re occurring in a market where people give every indication of being convinced the economy doesn’t warrant them.
Take hedge-fund positioning, for example. While professional speculators have tiptoed back into equities in the past two weeks, they’ve done so while playing it safe. Managers are snapping up shares of health-care and consumer staples companies, and shunning industries that are more dependent on growth.
Similarly, stock managers whose charters confine them to bullish bets have been gravitating toward defensive firms. Measures of their positioning hasn’t shown more pessimism on the economy in at least 16 years.
“They’re jumping in the water with their water wings on,” Jonathan Golub, Credit Suisse’s chief U.S. equity strategist, said by phone. “Even those going back into the market are doing so pretty defensively. That to me is a really big sign that there’s no real conviction.”
Stocks both plunged and recovered with unprecedented speed, prompting strategists everywhere to question the staying power of the rebound. Since history provides no blueprint, maybe it makes sense investors are buying while bracing for the worst.
According to an Evercore ISI survey of institutional equity managers and hedge funds, exposure to more economically sensitive industries versus more classically safer ones has fallen to the lowest ever in data going back to 2004.
To be sure, some of the trend reflects an appetite for health-care stocks, a traditionally defensive group that you don’t have to be a worrywart to love right now. The share of respondents saying they’re overweight the sector jumped to the highest ever versus those who have a smaller weighting to the industry than their benchmark.
But the taste goes beyond makers of potential virus treatments to embrace consumer staples and communication services firms. Hedge funds piled in here, too, while they cut exposure to the likes of energy and materials stocks.
The trend has been prevalent among exchange-traded fund investors too. They’ve poured more than $5 billion into health-care ETFs in April, on track for the most of any month in at least seven years and more than any other sector, data compiled by Bloomberg show. Meanwhile, utilities funds are set to see more than $1 billion enter their coffers for a second month this year, a milestone that hadn’t been breached since 2016.
Such preferences are filtering through to price action. Since the trough on March 23, health-care equipment and services firms in the S&P 500 have surged 40%. An ETF that tracks gold miners is up 60% over the same time period as the price of gold has risen to the highest in seven years. Real-estate and utilities shares have risen more than 30%. That compares to a 25% gain for the S&P 500.
Credit Suisse’s Golub highlights the same taste for safety has been apparent across quantitative equity factors too, which classify stocks based on different characteristics like growth potential or volatility. Low volatility companies with less debt and a higher return on assets have on average outperformed the broader market by 90 basis points on days stocks have fallen, his analysis shows. On the other hand, these factors are only losing 20 basis points on days equities rally.
“What you’d really want to see is that when the market’s going up, it’s going up with lower quality stuff, because that’s really a sign that people are not only getting in, but they’re getting in with stuff that is more economically sensitive,” he said. “They’re not -- they’re getting in with the stuff that is the least economically sensitive.”
Such hesitation has been acutely evident in companies with shoddier finances. A Goldman Sachs basket of stocks with strong balance sheets has risen to the highest level versus an equivalent gauge of firms with weaker balance sheets since 2009. A relative ratio of the two indexes’ price performances peaked on March 9, 2009 -- the day an 11-year bull market began, but only after half of the stock market’s value was erased.
Sameer Samana, senior global market strategist at Wells Fargo Investment Institute, sees a range bound market with 2,900 marking the upper end for the S&P 500 in the near-term. He says now is a good time to be trimming exposure to more cyclical sectors including energy, materials, and industrials.
“There’s still this mentality that bad economic news is good for equities because of lower rates and inflation and more stimulus,” said Samana. “While that may be true to a point, fundamentals do matter and the equity markets find themselves time and again catching down to rates because they’re reflecting the weakness in the underlying growth trends.”
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