Source: Jin10 Data
Since May, hedge funds have been selling technology stocks, and their next move will be...
The hedge fund's election trading strategy this year has always been to sell winners' stocks now, free up funds for aggressive buying in the fall, and welcome the political showdown's heating up.
Since May, hedge funds have been doing so, even as the market continues to hit new highs. Data from Goldman Sachs’ brokerage department shows that hedge funds’ net leverage ratio fell to 54% in early July, the lowest level since January. After selling the best-performing stocks in the market for two consecutive months, hedge funds have now reduced their holdings in the technology, media, and telecommunications industries to historically low levels.
However, this is not a bearish outlook. Rather, the so-called "smart money" is preparing for the intense U.S. presidential campaign, hoping to immediately use funds to bet when the stock market becomes volatile and stock prices begin to fluctuate.
"Managers need to keep enough cash on hand to deal with potential market volatility from the U.S. election. Net selling is a strategic profit-taking and a braking instead of an evacuation," said Jonathan Caplis, CEO of hedge fund research firm PivotalPath.
It's easy to understand why traders are preparing for the volatile election season. Democrats are still looking for a suitable presidential candidate, and calls for President Biden to retire due to his age and physical condition are on the rise. At the same time, the economic agenda proposed by the Republican nominee, former President Trump, includes tax cuts, increased tariffs, and restrictions on immigration, which has raised concerns about inflation and the deteriorating U.S. fiscal situation.
Known events with unknown outcomes create a trading environment where individual stock differentials (i.e. the range of potential outcomes when stocks move in different directions) rise. This is good news for hedge funds, as they typically take both long and short positions in betting.
Given the many uncertainties, some traders expect the election campaign to reach the stock market earlier than usual.
"What we've heard from hedge funds this year is that the election story may happen much earlier than November. Reducing risk before an uncertain event is a prudent and good investment portfolio management strategy," said Adam Singleton, chief investment officer of External Alpha, a subsidiary of Man Group Plc.
Hedge funds' exposure to stocks usually declines before the presidential election, and managers quickly reduce leverage shortly before the vote, and continue to increase positions after the vote. Goldman Sachs' data shows that the current net exposure is still higher than the long-term average of the election cycle, indicating that there is still room for further selling.
"Usually before these major events, it's often act first and analyze later," Caplis said.
Hedge funds typically use several methods to trade political events. One approach is to identify themes that benefit from each candidate by industry, reduce exposure before the vote, and then increase exposure to winning themes after the vote.
Another approach is to measure the overall risk appetite of the market, which can be regarded as a representative of stock price trends. In this case, the fund will first reduce net exposures, and then try to understand how investors view the winners. This wait-and-see strategy worked well in 2016, when the market expected a Trump victory to cause the stock market to decline, but it actually rose after Trump won.
Finally, the riskiest method is to focus on specific companies or a small number of stocks, expecting them to perform well or poorly based on who wins. This is the hardest trade to make, as once the winner is announced, market pricing can fluctuate dramatically.
"Many managers will try to observe how things develop after the election and then take action," Singleton said.
Currently, there is a significant risk for hedge funds that want to actively sell technology giant stocks that have pushed the market higher over the past year, such as Nvidia, Meta, Amazon, and Google parent Alphabet.
Antimo Senior Portfolio Manager Frank Monkam said that although this rotation may make sense, these stock prices should eventually stabilize, but if they continue to ignore gravity and continue to rise in the short term, there may be a "squeeze." In this case, as the expected drop fails to materialize, more investors join the buying, forming a self-fulfilling cycle of stock price rises.
In the end, November's trading will determine whether selling the winners is the right decision. Hedge funds can use these returns because they have been lagging behind the S&P 500 index for the past four years. According to PivotalPath's data, the profits of long-short fundamental hedge funds in the U.S. in the first half of this year are only 7.4%, while the S&P 500 index rose 14%.
One area where hedge funds have already won over significant demand is for their services. As the election approaches and stock prices approach historical highs, investors are becoming increasingly cautious and in need of guidance on how to allocate their portfolios.
Don Steinbrugge, the President of Agecroft Partners, a global hedge fund consulting and marketing company, said, "Investors are concerned about the valuation of the stock market and they want to hedge. If they weren't concerned, they would just buy an index fund, and that would cost them almost nothing." He said that this is the greatest demand for long-short equity fund managers since 2013.
Editor/Lambor