Titan – collective hedge fund slaughter provides further opportunity for us
The last few weeks have been brutal in “hedge fund hotel” world with serious bloodletting for many of the revered names in the industry. As we relayed here – http://www.spreadbetmagazine.com/blog/top-bottom-hedge-funds-during-1q-2014.html – some of the largest funds are now down nearly 20% (and probably more in recent days as these stats were only to the end of Q1) for the year. Ouch!
The ongoing liquidity withdrawal by Ms Yellen and the effective reversal of 6 years of ultra-loose monetary policy are being blamed for the takwdown with the more speculative areas of the market like the biotech and the technology arena’s being hit the worst. With QE ending, “risk” is now being re-priced.
At the beginning of the year, the VIX (volatility measure) was hovering around 14 but, in recent days, it has risen quite sharply and, although not breaching the key 20 level as it has done on previous shakeouts during the last few years, had risen to over 17 last Friday. During the current month, we have in fact seen the Nasdaq 100 index decline 3.1pc on the 10th and 2.6pc on the 4th – declines of a magnitude that have not been seen for a couple of years and which are significant drops for single sessions. The market even extended its declines in following trading sessions – classic bear market onset signs.
While hedge funds collectively continue to search in vain for the coveted “alpha”, as detailed in this blog here – http://www.spreadbetmagazine.com/blog/hedge-funds-and-the-lopsided-boat.html in which we revealed the massive headlong pile into the so called “momo” stocks, this is now really biting them in the backside with names like FB, CFLX & TWTR down 30 – near 50% from their New Year highs – a situation that we also pointed out as being ripe for unwinding here – http://www.spreadbetmagazine.com/blog/titan-investment-partners-why-we-have-moved-to-a-maximum-net.html. It seems that many of these funds have been massively unwinding their positions, and leverage, particularly to growth stocks and rotating into value plays. Yet again we were ahead of the pack with this blog here – http://www.spreadbetmagazine.com/blog/titan-investment-partners-why-were-backing-the-mining-sector.html. It seems also this poor sentiment is now spilling over to the wider public with some mutual funds experiencing significant redemptions lately, something that also happened in the aftermath of the tech bubble bursting at the turn of the millennium.
Of course, we are now in a different situation to 2000 as valuations aren’t as extreme as they were back then when many equities, with no track record of a single profit, were seemingly worth billions. Still, price ratios are still high and at similar levels to the pre-2007 crisis. It is true that the rise in VIX from 14 to 17 is not an extreme move and that credit spreads have in fact improved this year, in particular in Southern European countries. It is also true that the “risk-on” trade is still intact evidenced by the dollar and gold not rising dramatically – typical harbingers of further stock market falls. But the cracks are well and truly beginning to show now… We expected a sharp rebound this week as detailed here – http://www.spreadbetmagazine.com/blog/titan-has-the-bear-finally-begun-to-growl.html and so it has come to pass, but we do believe the 5 year bull market is slowly morphing into a bear one.
Companies have also been engaging in a massive share buyback policy. By reducing the amount of shares outstanding they have been able to act as a suppressant on PE ratios rising too fast (through flattering earnings). That is one of the biggest differences from the late 90s. But even if a major bubble is now being deflated in the tech arena, it is unarguable that stocks are on the expensive side and so it is the wrong time in the investing cycle, in our opinion, to go all in on equities as many of these hedge funds had until the last few weeks. Companies will eventually stop buying back their stock and, with their profit margins at record highs, they will also likely experience a declining profit growth profile in the near term. The joint effect of these 2 issues will probably further dent price appreciation potential for the wider market.
For now, hedge funds are seeing an increase in risk and are also on the defensive. They will probably continue to unwind positions to avoid the worst, namely redemptions. We will look out for opportunities in some of the better tech names in the sessions ahead to, as ever, take advantage of the markets collective over reaction.
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