• Subscribe
  • Log In
  • Home
  • Daily Diary
  • Asset Class
    • U.S. Equity
    • Fixed Income
    • Global Equity
    • Commodities
    • Currencies
  • Sector
    • Basic Materials
    • Consumer Discretionary
    • Consumer Staples
    • Energy
    • Financial Services
    • Healthcare
    • Industrials
    • Real Estate
    • Technology
    • Telecom Services
    • Transportation
    • Utilities
  • Latest
    • Articles
    • Video
    • Columnist Conversations
    • Best Ideas
    • Stock of the Day
  • Street Notes
  • Authors
    • Doug Kass
    • Bruce Kamich
    • Jim Cramer
    • Jim "Rev Shark" DePorre
    • Helene Meisler
    • Jonathan Heller
    • - See All -
  • Options
  • RMPIA
  • Switch Product
    • Action Alerts PLUS
    • Quant Ratings
    • Real Money
    • Real Money Pro
    • Retirement
    • Stocks Under $10
    • TheStreet
    • Top Stocks
    • Trifecta Stocks
  1. Home
  2. / Investing
  3. / Industrials

Sector Rotation Is Powerful: This Tech Hit Is a Great Trade

As hedge funds are forced to unwind tech positions, here is how to play the rotation.
By MALEEHA BENGALI
Jul 31, 2018 | 06:20 AM EDT
Stocks quotes in this article: ABT, PEP, CL, XLK, XLC, AMZN, FB, GOOGL, NFLX

Over the last few days, we have heard and seen all sorts of creative investment basket acronyms in the tech sector from FAANG to FAANGMA, or the new AGMA (ok, I just made that one up). It does not change the fact that everyone and their mom was invested in the tech sector, given its phenomenal growth of around 30% in large-cap companies of about $100 billion or larger. As Barrons wrote in an article recently, compare that to likes of Pepsico (PEP) , Colgate-Palmolive (CL) , and Abbot Laboratories (ABT) , which trade higher than 20x 2018 numbers yet only give growth of around 6%-8%. So one can be forgiven for hopping on this gravy train.

Despite the above-average growth rates, when momentum is so strong behind such names, the bar to beat earnings is even higher. Two out of the five FAANG names disappointed quite badly. Netflix dropped 15% on weak subscriber numbers. Facebook fell 20% on a revenue miss and projected slowdown, which is decent still but a marked-to-market lower number. On the other hand, Amazon blew the lights out and reported massive profits. But the stock is still 6% off its highs. What gives? 

Forgetting the mom and pops who invested in tech sector via ETFs such as the Communication Services Select Sector SPDR ETF (XLC) or the Technology Select Sector SPDR ETF (XLK) , which focused on the top names, if you look at recent prime brokerage filings, hedge funds consensual long positions were in Tech names like Amazon (AMZN) , Facebook (FB) , Alphabet (GOOGL) , Netflix (NFLX) , etc. According to hedge fund 13F filings, the average long portfolio vs. average shot portfolio has dropped by 2 standard deviations -- that is a big hit. According to some quant models, the HF L/S model is -1.8% and Momentum sector neutral is down 2.3%. They were invested very heavily in this sector, the darling of the Street. For example, Susquehanna, a global quantitative trading hedge fund, owned about 6.5% of its portfolio I in Facebook, not counting the undisclosed amounts of options the fund owns on it.

Hedge funds are run by leverage and tight capital controls. When a position blows up (or two), that fund has a limit as to how much loss it can take in a specific book before it has to cut its position immediately, regardless of fundamentals. It is like trading with a gun on your head. If you get it wrong, risk department calls you, you have to take your risk down, stay on the sidelines for a bit, lick your wounds, then slowly pick up after earning your credibility back. 

When even a little pebble or two falls into a calm lake, it will cause a few ripples across the surface. Being an engineer by background, I can be forgiven for appreciating a 2 sigma move seen in the market. Events that are considered "tail events" occur rarely -- maybe once a year. To put it in perspective, the global financial crisis was a 25 sigma event!! (near impossible -- hence all the machines were unable to predict it). When funds need to trim risk, cut their longs and buy back their shorts, this means all the favoured fundamental "overweight" positions get hit, and the expensive "underweight" positions rise. Out of sync right? That is what an unwind does. This move is all technical; risk management 101.

The market does not move much at the top level, but what is happening underneath the surface is far more relevant. About 50% S&P 500 return comes from tech names. So one can forgive the S&P 500 for being down from its highs, but just 2%. Look at sub-sector rotation, it is a lot more grabbing

The one good thing about these "sigma" events is that it purges the system, clears the noise (in this case weak hands and fast-money traders who added into this names at the top hoping to make a quick buck), levels the playing field for one to do their homework and cherry pick the key names that have been bashed up along with everyone else.

The average retail investor will not see or understand the gravity of this, but only see the sensationalist headlines put forth, saying "Tech rally is over, what now?" Over the past week, sectors such as financials, retail, healthcare, industrials and materials have been benefitting at the cost of tech. This is also dubbed as the rotation between growth into value (the reverse of the trend that has been in place over the last few years).

As the dust settles over the next few days, don't be too focused only on tech. Take a look at cyclicals/industrials. With China stimulus easing in the background and copper trading back up to $6200 a ton, along with mine strikes that are threatening to take supply out of the market, the miners are slowly grinding higher, without anyone noticing. People are underweight these names, and pretty soon they can rally 10% with more rushing to cover their shorts. Most funds have been underweight this space given China trade war jitters.

Unwinds are great trading opportunities, especially if the fundamentals are aligned as well. Don't just see the screen and be obsessed with the sea of red, see what is happening or can happen as the second derivative impact; the lateral trading opportunities are where you find the gravy.

Get an email alert each time I write an article for Real Money. Click the "+Follow" next to my byline to this article.
TAGS: Investing | Global Equity | Industrials | Technology | Futures | How-to | Markets | Risk Management | Stocks

More from Industrials

This Deep Value Portfolio Managed to Hold Its Own in 2019

Jonathan Heller
Dec 13, 2019 11:00 AM EST

The 22 stocks in the Double Net Value Portfolio collectively outperformed the value components of the Russell 2000 and Russell Micro indices.

Sector Geography Lesson, Japan's Stimulus and Zooming In on Zuora: Market Recon

Stephen Guilfoyle
Dec 5, 2019 8:48 AM EST

Plus, the Saudis look to press their oil agenda while Europe prints some ugly economic data.

PPG Industries Can Rally Further Into 2020

Bruce Kamich
Dec 4, 2019 8:20 AM EST

PPG is looking forward to more electric vehicles, because EVs require two to four times as many coatings and adhesives as traditional vehicles.

These Two 'Contenders' Fight for the Dividend Aristocrat Title

Chris Versace
Nov 30, 2019 10:17 AM EST

NextEra Energy and Lincoln Electric Holdings both appear lined up to become Dividend Aristocrats soon -- here they duke it out for top choice.

The Issue With Deere Is Its Guidance

Timothy Collins
Nov 27, 2019 12:59 PM EST

I expect Deere to continue on its downward path.

Real Money's message boards are strictly for the open exchange of investment ideas among registered users. Any discussions or subjects off that topic or that do not promote this goal will be removed at the discretion of the site's moderators. Abusive, insensitive or threatening comments will not be tolerated and will be deleted. Thank you for your cooperation. If you have questions, please contact us here.

Email

CANCEL
SUBMIT

Email sent

Thank you, your email to has been sent successfully.

DONE

Oops!

We're sorry. There was a problem trying to send your email to .
Please contact customer support to let us know.

DONE

Please Join or Log In to Email Our Authors.

Email Real Money's Wall Street Pros for further analysis and insight

Already a Subscriber? Login

Columnist Conversation

  • 10:10 AM EST BOB LANG

    Banking a Big Winner in SRPT, Rolling Up

    Nov. 20 here on the CC, I mentioned buying some Ma...
  • 10:36 AM EST GARY BERMAN

    Fibocall: How High Can Crude Go?

    On crude: I am looking for higher, but please b...
  • 08:20 AM EST BOB LANG

    Webinar Time - Talkin' Calendars, Butterflys

    join me later today after the market close as we t...
  • See More

COLUMNIST TWEETS

  • A Twitter List by realmoney
About Privacy Terms of Use

© 1996-2019 TheStreet, Inc., 14 Wall Street, 15th Fl, NY, NY 10005

Need Help? Contact Customer Service

Except as otherwise indicated, quotes are delayed. Quotes delayed at least 20 minutes for all exchanges. Market Data & Company fundamental data provided by FactSet. Earnings and ratings provided by Zacks. Mutual fund data provided by Valueline. ETF data provided by Lipper. Powered and implemented by FactSet Digital Solutions Group.

TheStreet Ratings updates stock ratings daily. However, if no rating change occurs, the data on this page does not update. The data does update after 90 days if no rating change occurs within that time period.

FactSet calculates the Market Cap for the basic symbol to include common shares only. Year-to-date mutual fund returns are calculated on a monthly basis by Value Line and posted mid-month.

Compare Brokers

Please Join or Log In to manage and receive alerts.

Follow Real Money's Wall Street Pros to receive real-time investing alerts

Already a Subscriber? Login