Hedge Funds Turning Doubtful on Staying Power of Recovery Trade

Once believers, professional investors are getting antsy about stock bets tied to a smooth reopening of the American economy.

Hedge funds that make both bullish and bearish equity bets spent Monday -- the worst opening day in five years -- leaning back into what has come to be known as the stay-at-home trade, buying lots of online tech companies optimized for lockdown commerce. Their preferences showed a shift away from the travel-leisure-retail group they’d favored in the second half of 2020, data compiled by Goldman Sachs’s prime brokerage show.

It happened as virus angst mounted, with infections surging and vaccine distribution short of hopes.

“When we think of what could possibly derail these lofty expectations of a second-half economic boom, it has to do with the race between the vaccines and the virus,” said David Rosenberg, founder of Rosenberg Research & Associates Inc. “Nobody said it’s not a big bull market. It’s just one premised on cheap money rather than solid fundamentals. Hence the speculative fervor.”

When the S&P 500 dropped 1.5% Monday, hedge-fund clients tracked by Goldman reduced short positions in companies that cater to at-home demand, such as internet and software shares, with a basket of such stocks seeing the biggest net buying in three weeks. Meanwhile, reopening companies, like airlines and cruise operators, experienced the largest net selling in two weeks.

On the bright side for bulls, hedge funds remain net buyers. Their long/short ratio, a measure of equity tilt, stood at the 97th percentile of a three-year range, Goldman data shows.

Dip buying paid off Tuesday, though the lockdown winners lagged behind. Stocks added 0.9% as of 2:12 p.m. in New York. Goldman’s basket of reopening stocks outperformed the stay-at-home set by almost 1 percentage point.

While skepticism may be rising among hedge funds, most of the investing public continues to embrace a rally that has added $19 trillion to equity values since March. Everyone from day traders to long-only money managers have been piling in on stocks. Equity funds are attracting fresh money at one of the fastest paces on record and cash is dwindling on online brokerage accounts. All despite persistent warnings over bubble valuations.

At almost 30 times reported earnings at the end of December, the benchmark sported the highest multiple to start a year in at least six decades, data compiled by Bloomberg show. Add to that surging IPO stocks, often among companies without profits, and record offerings by special purpose acquisition companies, or SPACs, and it’s reason for caution to Tobias Levkovich.

“The Street has ignored them all, preferring to go with the flow,” said Levkovich, Citigroup Inc.’s chief U.S. equity strategist. “While the specific catalyst for an adjustment is generally hard to identify, we think the chances of a significant pullback is growing and investors need to address extended exposures.”

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