MORNING BID: Mo-Mo and the Hedge Fund Reckoning

May 15, 2014 13:34 UTC

Who had the mo-mo mojo and who was crushed by the steamroller becomes evident late in the day Thursday when filings from major hedge fund managers – those things known as 13-Fs – are released.

Hedge funds were hit hard by the decline in the likes of Twitter, Tesla, Netflix and a lot of other names that long/short investors had favored throughout 2013 and early 2014, but their substantial decline cut the legs out of a lot of leveraged managers looking to continue to profit on the big run-up in that sector.

Credit Suisse data shows that investors were generally overweight in the momentum strategy (one of a number of style baskets), especially after a stellar 2013, when stocks ran up all at once. They responded in late March by putting on substantial hedging positions to offset some of those losses and as the declines faded, performance normalized a bit more. There are still some believers (there always are when it comes to internet software and biotechnology companies) but still more investing firms are now going the other direction, boosting their short bets in these names and pulling away from the long side.

Many of these managers had maintained long positions in names as they kept falling. In recent weeks, though, investors have instead started to add to short positions – 3D Systems’ short interest is now hovering about 22 percent, up from about 15 percent at the beginning of the year, according to Markit. SolarCity has seen overall short interest utilization rates rise to about 76 percent from about 20 percent at the beginning of the year (oddly with this name, short bets were very high in 2013, but fell off as skeptics gave up in the face of the overwhelming market rally).

Netflix has been a bit less of a heavily shorted name, but it too has seen a modest increase in short bets, from just 1 percent in mid-January to about 10.5 percent as of this week, Markit data shows. It will be interesting to see if there are any that detail sudden reversals in exposure – from long to short – or vice versa.

(One notable exception to this trend is Twitter, which has seen a notable decline from its heavy short interest in recent weeks. According to Markit data, about 90 percent of the shares available for borrow were being used for such purposes on May 6; by May 12 that had dropped to about 50 percent of shares available to borrow. The reason for this is relatively easy to explain: Twitter’s lock-up period preventing certain insiders from selling expired on May 6, so there’s more available to borrow for short bets.)

That the big selloff in these names didn’t spread to the broader market in any meaningful way is the result of a few things. For one, the stocks were overvalued by most conventional and a few unconventional measures. Also, they didn’t encompass large swathes of the market the way the tech bubble did in 2000, and most other sectors of the market have remained steady on expectations for better economic growth, so the rotation to the likes of utilities and consumer staples stocks has helped offset the losses in the big momentum stocks.

And now, it’s gotten to a point where these hyper-growth names are even undervalued when compared with their historic relationship to the market. Hyper-growth names that derive more than 40 percent of their enterprise value from their future growth prospects trade at about a 51 percent premium to the broader market, per Credit Suisse figures. That’s usually 66 percent, meaning this is where buyers could step in…if they wanted.


Apr 11, 2014 12:51 UTC

The question of whether the market is going into a longer, broader correction is one with a lot of wrinkles.

Whether these high-flying stocks are going to come back is the easier question to answer. Why? Because unlike stocks where most of the embedded value is in existing earnings and existing growth – things a person can cling to, like the utilities or telecom – these stocks ride based on their expected growth for years down the line.

And when the unknown is combined with optimism you get price-to-sales ratios of something like 20. So when they cheapen – that is, sell off – those price-to-sales ratios (just another way of valuing a company) they drop to 15 times sales, which when compared with the S&P 500 is still ridiculous (the whole index tends to run around the 1.7 area of late). Which tells you of course that valuation was never the name of this game to begin with.

So with the valuation not there, and investors no longer getting the gratification from seeing stocks rise as soon as they buy them, there’s a couple strikes against them. A third one is supply. Motivated sellers, knowing they bought the stock at higher prices, are therefore champing at the bit to get out of positions if the market surges to a level they’re satisfied is enough to either lock in profits (if they’ve been in a while), get out at even (if they bought recently) or get out with losses because they know they’re screwed. Because, make no mistake about it, people who bought these high-flyers this year are underwater, sometimes seriously so, and unless sentiment does a complete about-face, these “investments” suddenly don’t look like so much fun to own. Broken momentum stocks are an ugly thing – just ask those who rode shares of Crocs into oblivion.

How are we so sure of this? Using volume-weighted-average price data (and a big tip to Mike O’Rourke of JonesTrading for cluing us in on this). Using Datastream, we found that some of your momentum favorites have been on average purchased at much, much higher prices this year than they stand now.
A group of 24 big-gaining names with most of their value wrapped in future expectations, as identified by Credit Suisse, have disappointed those who jumped in this year hoping for lots of gains.

We won’t go through all 24 here, but here are five favorites, listing the VWAP, or average price investors have paid this year, along with Thursday’s closing price, and the difference between the two:

  • 3D Systems $71.90 $48.78 -32.2%
  • Twitter $56.81 $41.34 -27.2%
  • SolarCity $71.17 $55.13 -22.5%
  • Workday $94.28 $75.62 -19.7%
  • Netflix $385.91 $334.73 -13.2%

Not much to like there at all. On average, investors in Twitter in 2014 are down 27 percent from where they bought the stock, and it’s not even as if a 27 percent gain will get them to break-even - at $41.34, that stock now needs to rise by 37 percent to get back to this break-even VWAP level.
That’s a tall order, especially when sentiment is moving against the shares and hedge funds are correcting themselves from being more overweight in momentum than they were any of the other style factors that strategists measure (which include things like beta, volatility, earnings yield, dividend yield, and a few other metrics).

If there was one area that wasn’t constrained by the hedge fund managers, it was momentum – thanks to a rosy 2013 that many figured would just roll on in 2014. It’s been anything but that. Now, some strategists are warning that earnings are the next point of measurement and sure, that’s true – but that’s more for companies within a small range of where most think they’re valued. These stocks are different – the forecasts for growth over coming years vary wildly, because with names like this, things are just inexact (and even more so with biotechnology names, which are frequently all-or-nothing stocks).

Momentum works two ways – and now it’s working in the wrong direction for the bulls.

MORNING BID – Netflix, and a bear’s lament

Jan 22, 2014 17:27 UTC

The week opened with the earnings of a number of high-profile corporate names that disappointed investors. Most notable of these was International Business Machines, which really ought to be called International Buyback Machines, given Big Blue’s penchant for driving earnings through financial engineering rather than, y’know, the real kind of engineering.

IBM fell short on revenue estimates, saw shrinking demand in part because of reduced government spending (China’s government, not the US), yet exceeded net income estimates because of – what else – a lower tax rate, now at 11 percent vs 14 pct a year ago.

Margins continue to shrink – the pre-tax margin for the fourth quarter dipped to 25.1 percent from 26.7 percent a year ago. So, in some ways, it’s a microcosm of the recent earnings trend – cost-cutting, relying on government largesse, moving money around, and making per-share earnings look better by just changing the whole “per share” thing.

IBM’s not the only company that mirrors the S&P 500 writ small. Another is Netflix, the streaming media company that was the S&P 500′s best performer in 2013 and reports earnings after Wednesday’s close.

The bear case is pretty much handled by pointing at a chart of the stock rocketing into the stratosphere, looking into the TV cameras, and saying “Seriously?” Which is pretty much how some of the bearish types on Wall Street think of the entire market right now, believing they’re the only sane ones on earth while everyone else is crazy.

But we know how that goes when it goes wrong, and with Netflix, all those bets against it went wrong all year – causing short interest on the name to dip from the mid-20 percent area to a miniscule 0.93 percent of the float, according to Markit, which puts it in ExxonMobil territory.

Analysts expect a gain of about 2 million U.S. subscribers, and Wall Street forecasts net income of $41 million, five times the $8 million it recorded a year earlier.

The expectations at least remain positive, so that’s something. But there’s an irony here – the stock more than tripled in 2013, and from an intrinsic value basis, ranks as one of the worst in Starmine’s greater universe: The $330 price in the market should be closer to $61 a share, according to Starmine, as its forward price-earnings ratio currently stands at about 83, when it warrants somewhere around a 19 P/E.

The idea that the overall market is just as overvalued as Netflix doesn’t quite pass the smell test. You can hear the bear’s lament in the discussion of the broad market just as can be heard in the NFLX discussion – one that waned as the stock kept rising.

MORNING BID – Short Stack

Jan 21, 2014 14:57 UTC

The week brings a slew of earnings, and then anticipation of the following week, which will bring the Federal Reserve’s last meeting chaired by Ben Bernanke, with media reports already starting to concentrate on the Fed and look past results a bit.

That’s a mistake, of course – the outlook for corporate America vs. a predetermined outcome from the central bank is a no-brainer – but the Fed’s continued exit underpins the shifting sentiment in the market right now.

That is, short sellers are starting to feel a bit more confident, even if the market isn’t at a point where wholesale short bets are being rewarded (if you bet correctly, say, on JC Penney, you’re aces).

As Reuters’ Rodrigo Campos and Sam Forgione wrote in a story over the weekend, Credit Suisse’s prime services group shows the funds with a long-short bias are still leaning long, though a bit less than in the last week (55 percent, which is still bullish). (Full Story)

Notably, though, the market’s 20-day moving average for the S&P 500′s average daily trading range has dropped below six-tenths of a percentage point, which is about as dull as one can get when it comes to the markets. That’s data from Mike O’Rourke of JonesTrading, who also points out that such dead time (the time when it’s also impossible to go short) either ends up in a breakdown or a breakout in shares.

Right now, one would have to bet on the former; the forward price-to-earnings ratio sits around 15 and change right now – about at the historic average or so, and at a time when an increase in multiples seems a bit far-fetched.

If there is going to be volatility, it’s going to come as a result of the surprises we see in the earnings data.

The pattern has oddly reversed this time out: More companies are beating on revenue rather than earnings, with just half of the companies that have reported exceeding earnings estimates.

Some of that is because revenue expectations have been damped dramatically; the expectation is for just a 0.5 percent rise in revenue, which is pretty much the coffee-and-donuts budget at most major companies.

For earnings, though, the forecast was for a 7 percent increase, which may be a bit too lofty. StarMine has Noble Corp, Crown Castle, Lockheed Martin and Textron pegged as those that may miss current forecasts, while they see Travelers and Teradyne as more likely to beat estimates.

Other bellwethers include Texas Instruments, good as a barometer for overall chip activity given their technology is used all over the place, Johnson & Johnson, Verizon, and Netflix. The latter has been a target of shorts in the past, until the last remaining short seller of the name, bankrupt and penniless, moved to an ashram or something.