(Bloomberg) — This year’s market turmoil brought an unexpected respite for long-suffering active managers: fortunes swapping between individual stocks.
As the S&P 500 kicked off its worst month since the pandemic, shares actually went lower and simultaneously lower in January. This is unusual – equity correlations tend to rise during bouts of turmoil, a pattern that has played out in every drop of 10% or more for the past decade.
This is a potential boon for stock pickers, who have a greater chance of outperforming the broader index when stocks tend to beat on their own. What’s more, Bank of America Corp. Clients were net buyers of single shares in recent weeks, while their inflows into exchange-traded funds declined. This is a departure from the past 12 months, when investor cash was primarily put into ETFs.
Many hedge funds were badly positioned during the January round. But the upcoming Federal Reserve rate hike threatens to cause more violent disruption in the market – providing money managers with new opportunities to outperform benchmarks and grab customer flows.
“It’s too early, but we’ve started to see some early signs of some more positive steady stock inflows and some slight declines in ETF buying,” said Jill Carey Hall, an equity strategist at BofA. “The chances are we may be getting closer to the tipping point.”
When the S&P 500 fell 10% from peak to trough during the rate-fueled January route, a measure of stock correlation — the extent to which gauge members went into lockstep — fell 0.1 points to 0.2, according to the data. by Bloomberg. In the last seven instances when the benchmark has faced similar selloffs over the past decade, the figure has risen by an average of 0.39 points. A reading of 1 indicates perfectly correlated moves.
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It’s not easy to pinpoint the exact reason for the low stock correlation in January. Some say the new year with elevated hedging means money managers don’t have to eliminate exposure across the board – something that typically accelerates equity co-movements. Others cite a reporting season where companies balk at their own news.
Consider last Thursday, when the S&P 500 fell more than 2%. While Facebook’s parent Meta Platforms Inc. erased a record $251 billion from its share value after disappointing results, T-Mobile US Inc. grew 10% on better-than-expected earnings.
Whatever the reason, it seems that the rotation away from richly valued tech companies is prompting investors to reevaluate the virtues of proactive management over strategies, according to Julian Emanuel, chief equity and quantitative strategist at Evercore ISI. Passively track benchmarks.
“And we think it’s likely to be a lasting change,” he said.
The thinking is that with stocks still hovering near their highest valuations in two decades as policymakers shun monetary support, it seems risky to bet indiscriminately through broad-based index funds.
Meanwhile, the gap between winners and losers is widening — clearly good news for money managers relying on varying stock returns to outperform the market. For example, the energy sector has risen 23% this year to beat communications stocks by 34 percentage points. This is the largest spread in a year in Bloomberg’s 1990 figures.
A favorable market background is no guarantee of success. While 51% of mutual funds tracked by BofA outperformed their benchmark in January, a Goldman Sachs Group Inc. The basket of long-short hedge funds lost 7.9% this year through Thursday, thanks to focused bets on growth stocks.
Mandy Xu, Head of Equity Derivatives Strategy at Credit Suisse Group AG, said, “Even in an environment where we saw large earnings, large sector rotation and low correlation, most fundamental long-short funds struggled due to their sector allocation and positioning. ” “Theoretically, an environment with low correlation is a better environment for stock picking, provided you choose the right stocks.”
— With help from Peyton Forte and Melissa Karsh.
