To casual observers, the stock market has traded in a relatively benign fashion over the past few days.
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| | | | To casual observers, the stock market has traded in a relatively benign fashion over the past few days.
But some remarkable shifts that took place underneath the surface caught the attention of strategists, and are inflicting severe pain on a number of hedge funds.
In short, there's been a massive rotation away from the best-performing stocks and into those that had been neglected. That means funds are dumping momentum stocks, or those that have had the wind behind their backs, in favor of value stocks, or those stocks that had been ignored and are considered cheaper.
Goldman Sachs said in a note that the decline on momentum "ranks among the sharpest on record," and Morgan Stanley sent a memo to hedge-fund clients, seen by Business Insider, trying to explain the moves and saying the pain could well keep going.
Here's what you need to know:
- The sudden and decisive rotation exposes how vulnerable investors have become to swings of this nature, according to Peter Oppenheimer, the chief global equity strategy at Goldman Sachs. In a recent note to clients, he said the rotation would most likely be short-lived and explained how to align with the longer-term winners.
- Marko Kolanovic, JPMorgan's global head of macro quant and derivative strategy, identified a pattern within the shift that has happened only twice before. Specifically, last week JPMorgan's momentum indicator of small-cap stocks reached its maximal negative reading, while the same indicator for large companies on the S&P 500 reached its maximal positive reading. A divergence of this magnitude has occurred only twice before, according to Kolanovic: in February 1999 and during the tech bubble. He said the move into value stocks was likely to continue and advised investors on how to be positioned so they can capture the strongest upside going forward.
- Hedge funds have been feeling pain as a result of the shift. "Everything that worked all year got sacked and whacked," one quant hedge fund source told Business Insider. "This has been a brutal move," said another person at a hedge fund in London. "Huge move and lots of pain. It was like a 4 standard deviation day followed by another 4 standard deviation day. That's unheard of."
- A Morgan Stanley sales desk sent a memo on Wednesday, outlining its traders' take on "the magnitude and velocity of this week's rotation." The note said that "all strategies are down," and warned that if the momentum "morphs" from short sellers covering to a wider selloff by longer term stock holders, "this is likely to spill over to the overall market."
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