Get ready as ‘beta-chasing’ stock managers try to make up ground

Bloomberg

It’s been the same trade all year. A recession is coming, so get defensive. Now the strategy is unwinding and stock managers who toed the line all the way into November have furious catching up to do.
That’s bad if you’re in charge of an equity portfolio that’s straggling. But for anyone hoping to ride along with more upward momentum in the market, the effect has been the opposite. Stocks just rallied for a fifth week, tying the longest streak in two years, spurred by a rotation into high-volatility shares.
“There’s so many people that were so bearish going into this rally that maybe they haven’t even turned bullish,” said Jim Paulsen, chief investment strategist at Leuthold Weeden Capital Management LLC. “And if you get all these portfolios reducing their bearish bets, that’s a lot of bullish fuel. That’s going down. It’s happening.”
As of the end of October, less than a third of large-cap actively managed mutual funds were ahead of benchmarks, compared with 41% in the first half of the year, data compiled by Bank of America (BofA) show. With less than eight weeks to go until 2020, this sets the stage for a year-end chase, says the bank, and managers will have to pile into highly volatile names — including deep value and cyclical stocks.
Overcrowding among all manner of professionally managed funds in defensive industries like utilities and real estate trusts has become extreme, according to the bank.
The spread in performance of the 10 most-crowded stocks and the 10 most-neglected ones has hit a record this year, it said.
But the recent thawing in trade tensions between the US and China and the anticipation of improving global economic growth have boosted prospects for riskier sectors. As the S&P 500 breaches record after record, anyone lagging even a percentage point behind its 23% gain has catching up to do.
The S&P 500 gained 0.9%, posting multiple record closes along the way. The march to all-time highs has been relentless — so fast that the S&P 500 has stayed above its 10-day moving average in 21 sessions, the longest streak since November 2014. “As we get more certain about global trade and that the economy is not going to be heading into a recession, you start to see more risk-on trades and the crowded positions get sold,” Chris Gaffney, president of world markets at TIAA, said by phone. “You may have some people say ‘In order to make it look good for the year, we’re going to have to get a little more aggressive here.’”
The shift in sentiment means previously unloved areas of the market, including small caps and cyclical companies, are back in vogue. European stocks, energy companies — all are rallying.
In a reversal from the first nine months, financials and industrials have been among the top-performing sectors during the latest leg, with banks up almost 10% so far this quarter. Value stocks are also back from the dead.
Defensive plays, on the other hand, are getting smoked. A long-duration fixed income ETF that saw money come in throughout the year is losing ground, as are low-volatility funds. A strategy that bets this year’s winners will keep on winning is also being drained of assets.
There’s historical precedent for a year-end ramp, according to BofA. In the typical year, when a majority of active funds are lagging as of October, high-beta stocks have led low-beta ones by 2.6 percentage points in the last two months. And 14 instances since 1928 when the S&P 500 was up more than 20% through October, it gained an average of 5.47% in the final months, according to Bespoke Investment Group.
That’s starting to play out. Data compiled by the National Association of Active Investment Managers showed money managers are rushing to buy stocks at a rate not seen this year. The exposure index hovered near its 2019 lows of 57% in mid-October and has since jumped above 90%. While it’s approaching this year’s peak of 95% seen in July, it’s a far cry from a record 120% reached in December 2017.
Among hedge funds, according to Credit Suisse, net exposure has jumped, though mostly driven by short covering.