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.
