Hedge Funds See Something In Reflation Trading They Don’t Like
While betting on an economic rebound has been the stock market’s biggest bet since the November presidential election, a group of investors have hung on to their chips.
Despite a rebound of at least 40% in energy and financial stocks in the five months, hedge funds – on average – have consistently avoided reflation stocks, instead favoring companies seen as resilient during an economic downturn. Their exposure to cyclical stocks is at one of the lowest levels this decade compared to defensive stocks, according to industry data compiled by Bank of America Corp.
Morgan Stanley customer data shows a similar, albeit less pronounced, pattern. After peaking in late 2020, the industry’s net exposure to the reflation strategy has declined to the 78th percentile over the past 12 months, according to the company’s senior brokerage unit.
What motivates aversion is not obvious. One theory is that hedge funds aren’t buying the back-to-normal story despite the vaccine rollout. Last year, when retail investors rushed to seek bargains from battered groups like airlines and hotels, professional speculators were are reluctant to drive out businesses ravaged by the pandemic.
Another explanation holds, which may be linked to fears that the economic acceleration, propelled by monetary and fiscal support, will run out of steam once the last federal spending runs out. Mike Wilson, equity strategist at Morgan Stanley, is a strong advocate for a shift to stocks better positioned to withstand potentially disappointing economic data, such as consumer staples.
“Now is the time to upgrade the portfolio and move to quality before slowing down rates of change in a number of macro indicators,” Wilson wrote in a note to clients on Monday.
Whatever the reason behind the cautious stance of hedge funds, it is starting to spill over into the wider market. Over the past month, utilities and consumer staples gained the upper hand over energy stocks, as surging bond yields stagnated even as hiring data and the service sector surpassed estimates.
Read more: Jobs data is ‘good news’ raising Fed’s stakes: investors react
For Tony Dwyer, strategist at Canaccord Genuity, investors should take advantage of any decline in the reflation transaction to increase their exposure.
“The only way to see this, in our opinion, is as a resumption of the ‘Capital V’ which is in the first innings, and the only thing that could stand in the way would be another shutdown of the economy to contain the new Covid- 19. strains or a Fed policy error, ”Dwyer said. “Neither of the two seems imminent.”
Compared to history, hedge fund exposure to financials and energy stocks now tracks all other sectors, according to data from BofA. Such skepticism bodes well for those stocks under-owned and trading at lower multiples of earnings or book value, according to the company’s strategists led by Savita Subramanian.
“Hedge funds have yet to embrace value rotation, which leaves room for increased positioning in the coming months,” they wrote in a note last week.