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.

MORNING BID – The small and the long

Apr 29, 2014 12:58 UTC

Stability is the name of the game right now in equity markets – something that can be seen in the daily moves in various speculative sectors and how investors react to outside influences like Russia and Ukraine (really, the primary factor motivating the more wild ups and downs in the stock market at this point). Signs that the tensions may be thawing – and we’ve seen this movie before – contributed to a rebound in the Nasdaq and other indexes later in the day to leave the tech-heavy index basically unchanged on the session.

But that didn’t help the biotech stocks, and the cloud names like Workday and Salesforce.com (now riding a four-day losing streak), and the sharp declines in these names is something that the folks at Bespoke Investment Group suggest is a phenomena that newer investors haven’t seen before. That is, when stocks just keep falling, and it shows that the break in momentum in these names hasn’t been arrested. “It’s rare for a market to become that information-insensitive (in either direction), so this has been a great learning opportunity for traders that haven’t seen a similar sort of move,” they wrote. It also gives lie to the idea that this was a tax-related selling issue. While those stocks have tended to pop up with the market – and this morning’s jump in futures shows that investors really do have Ukraine close at hand even if the effect is a third-order one – but any jump in the Nasdaq has been a selling opportunity for those names.

Meanwhile, the bigger tech names like Microsoft and IBM ended higher, and investors kept plowing money into utilities and telecom names like the boring AT&T (snooze) or Verizon (snore). As Bespoke puts it: “Our thesis is that
the rotation is hunting stability, and that traders are willing to bid up predictable long term cash flows, with
less emphasis on whether those cash flows are “rich” (high P/E) or “cheap” (low P/E),” they said.

Either way it helps continue a run of outperformance the large-caps have managed against the small-caps in recent history. Mike O’Rourke of JonesTrading notes that just 32 percent of speculative positions in the Russell 2000 are long right now, a sharp drop from 59 percent in early March – yet still higher than the average 25 percent from 2007-2011, suggesting if things get worse, more people could bet against the Russell. (The small-cap Russell has had a notable run, in that it’s about 350 days into a stretch of not closing below its 200-day moving average, a sign of long-term strength. Could this break be on the way? More knee-jerk selling would get us there.)

While growth isn’t entirely being discarded, the stocks with more of their price tied up in future expectations are being shed, and taking other ones with it, like Amazon, a two-time participant in momentum stock moves, which was hammered again on Monday.

MORNING BID – Biotech swings into earnings

Apr 22, 2014 12:48 UTC

Earnings get a bit less boring with a slew of biotechnology and medical device names out Tuesday, most of them after the closing bell.

Among those that will be most watched are Gilead Sciences, sort of the linchpin of this whole selloff the market’s been dealing with in the last several weeks, Illumina, one of the market’s biggest high-flyers in the last couple of years, and Amgen, which compared with these biotechnology names might as well be a telephone company in terms of volatility and overall sex appeal.

The declines in Gilead and other biotech names have been striking, as the stocks have underperformed the S&P 500 by double-digit levels since the full-scale run out of these names began late in February. Unfortunately the options market suggests the action after the closing bell (or even through the end of the week) might be a bit underwhelming. Ryan Detrick of Schaeffer’s Investment Research notes that the amount of bullish call buying compared with put-buying (bearish bets) in both Amgen and Gilead ranks at about the 55th percentile over the past year.

For Gilead, that means over the last 10 days we’ve seen about 218 call options written for every 100 put options, a healthy but unspectacular bit of action that points to generally bullish tidings. It’s certainly not something that suggests worry among investors after Gilead has been one of the market’s duds since late February, and especially since mid-March when lawmakers asked the company to justify its $90-gazillion price tag for its hepatitis C drug.

The at-the-money straddles (buying a call and put option at the strike price closest to the current price) suggest a move of about 5 to 6 percent by the end of the week, which also isn’t that exciting (this is biotech we’re talking about).

The more interesting action looks like it’s coming out of Illumina Pharmaceuticals, which has been basically hammered since it started to sell off with the rest of the momentum names in February – so much so that Goldman Sachs says their underperformance compared with the S&P 500 is enough to warrant a look as they might end up exceeding estimates. That would certainly put a spring in the stock’s step.

Parsing out what the options are saying here is a bit more difficult; Illumina doesn’t have any weekly options, so you’ve got to judge by the monthly contracts that expire in mid-May. Those are real bearish – Schaeffer’s shows a 10-day put-to-call ratio that’s more bearish than 98 percent of readings over the last year, so people clearly aren’t enamored of the selloff in this name and are protecting themselves against more hell to pay in this one.

The mid-May straddles suggest a move of 13 percent by the middle of next month, so that’s not all that reliable a guide for what’s going to happen this week, unfortunately; it just suggest more volatility.

“You can almost say Illumina is a typical biotech; Gilead is in the middle, a little more established, and then Amgen which does not really have a biotech tone to it with the option premium,” said William Lefkowitz, chief options strategist at vFinance Investments. (Amgen’s a pretty staid one in terms of options. The move expected is 3.4 percent by the end of this week, and it hasn’t been crushed the way other names have been, plus, its an $89 billion market cap company, or four times the size of Illumina).

MORNING BID – Big Mo, Oh No

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 – The same-store situation

Apr 9, 2014 13:36 UTC

Same-store sales figures may be enough to inspire some investors to resume paring portfolios of some consumer discretionary stocks that have underperformed in the last five or six weeks.

Equities rebounded on Tuesday, but the overall feeling is that the market hasn’t yet finished with the bout of selling infecting the high-volatility, high-beta names that dominate conversations.
Most consumer names aren’t in this rarefied air (they don’t trade at price-to-sales ratios of a gajillion) but they’ve still been a target for some time on bad news.

The ones to watch are the likes of Costco, expected to come in strongly, while teen apparel retailers face some pressure, even with easy comparisons to a year ago. Gap, Zumiez and Buckle all look to post worse year-over-year results for March, and Shoppertrak data has shown how mall visits have changed over time. People no longer wander the mall for hours, but find deals online, shop at a few stores, and get outta there. That’s not a weather thing, that’s a “how I run my life” thing.

This data is likely to be bad news. Excluding the drug store sector, same-store sales are expected to have grown at a 1.5 percent rate for March, down from the 2.7 percent growth rate for the ex-drug sector last year, according to the Thomson Reuters outlook.

Investors hope retailers see a pickup in the next few weeks and that the group’s earnings reports point to underlying demand that was at least seen in the car-sales figures and some signs of home-buying activity. That might revive some demand for that sector, which is down 5.4 percent since March 7.

Hedge funds seem to be still reducing positions in this area even as they don’t drop out of the market entirely; ETF flows this past week show more reduction in buying in consumer cyclical shares, according to Credit Suisse, though it hasn’t been terribly pronounced.

BUYING WHAT AND WHERE?
There’s been a bit of strange activity here and there in some of the official Fed and Treasury data.
First, a number of weeks ago, someone either sells or moves about $100 billion in holdings that had been custodied with the Federal Reserve – the biggest ever such move.

It has since been restored, and yet it remains a mystery; speculation had focused on Russia as the culprit, but no proof is there. Monday, new data showing who the buyers were of the most recent Treasury auctions (two weeks ago) showed a big buy by banks and other similar institutions of five- and seven-year notes. They accounted for about 15 percent of the auction, compared with about 0.11 percent of the February auctions of five- and seven-year paper.

Again, there’s not much in the real facts here and a lot of speculation – quarter-end positioning wouldn’t seem to make sense, as banks looking to shore up their balance sheets could just buy lots and lots of bills. Is it mortgages? Unclear.

MORNING BID – Momentum stocks: A primer

Apr 7, 2014 13:25 UTC

Lots of stocks have been getting killed in the last several weeks and the declines don’t seem really like they’re set to abate headed into a week where news is again at a premium (sure, earnings, but it’s just a few names, and they’re mostly decidedly not in this category of the momentum names that fueled the rally in 2013). So the likes of Facebook, Tesla Motors, Netflix, Alexion Pharmaceuticals, and a bunch of others have seen their fortunes turn in the market. But at this time we thought it would be a good way to get into this topic again by trying to lay out just what the hell a momentum stock is in the first place, because they exhibit a number of characteristics beyond just “a stock that’s going up very high.” So here goes:

Growing Industries: Internet retail, internet security, solar, cloud computing, companies that use the cloud for providing services (think Salesforce.com), biotechnology, and anything else where the prospects for growth are big and related to a growing sector of the economy. Utilities don’t really qualify here, naturally. The reasons are two-fold: for one, in order to jump onto a rising growth story, you’d want to be in a place where the expected future returns outpace the returns you’re getting now, something you won’t get from the telephone company, someone who sells toothpaste, or the guys hooking up the electricity.

Revenue, Revenue, Revenue: Credit Suisse’s quantitative research models shows that the big winners in 2013 were those whose price when compared to enterprise value showed most of the value in the stock wrapped up in their future growth prospects. Lots of these types are showing a big boom in the money they’re bringing in every year, even if that’s not translating yet into earnings – Tesla, for instance, saw its revenue rise by about 75 percent in 2011, which then doubled in 2012, and increased nearly four-fold in 2013. That’s growth, and that’s what feeds the expectations for more growth. The exception here is probably biotechnology, where much of the prospects are given over to expectations for a drug approval – though it’s notable that Alexion, for example, has posted revenue growth of 37 percent or better for five years running.

Rising Stock Price: This is sort of a no-brainer, but it’s a little more nuanced than just “OMFG LOOK AT THAT.” (Ok, maybe not much, but let’s unpack it anyway.) There’s a lot of talk about stocks that steadily rise and then go through a period of what people blandly call “consolidation,” but in a sense that kind of thing is important – it means that investors are seeing their stocks sit, churn for a while, and not really move, but those confident in the prospects and in the valuation of a company will buy as these dips occur, thus ensuring a “base” when the stock falls back. They’re not “value” investors, but they’re investors believing that a company’s value sits at a certain price where they’d be willing to buy, again and again. But these stocks exhibit no such pattern – they don’t really come up for a breather at all, and sort of just simply keep going and going and going. So investors who get into these names, including but not exclusively hedge funds, are doing it and finding what Mike O’Rourke of JonesTrading called “instant gratification from price appreciation.” When investors talk about stocks going “parabolic,” that’s what they’re referring to – look at Netflix last year, rising with barely a stop from around $90 to more than $450 a share.

Volume and Volatility: This is an underappreciated aspect of the stock-price move, and that when you see these stocks start to take off, often volume will bust out in a big way on the up days as more and more people jump in to take advantage. They also tend to move around a lot.

Short Interest: Not always necessary, but often an added part of this. Just as these stocks often attract hungry buyers, there are a lot of hungry sellers who jump in as well and believe – as is likely the case – that the valuations are absurd. But with momentum stocks, that doesn’t really matter, so you see lots of shorts get burned. Green Mountain Coffee Roasters, Tesla, Netflix and a few others are good examples of those that built a stubborn short base for quite a while. Eventually, they will be right, but they may not even be in the stocks anymore, having gotten run over by big big mo.

Faddish Industries: Those that buy these names can either be emotionally connected to a story – prostate cancer drug maker Dendreon had for years a fervent group of followers who lived and died on every regulatory announcement – or they come out of brands that naturally attract buyers because they have a consumer appeal as well. Netflix, Priceline, TripAdvisor, or Tesla all work in this description. Sometimes they’re even an outlier in an otherwise slow-growing industry because of “fad” appeal – Crocs was a big momentum stock for a long time too.

So what’s all this make out as? The question is when people start to find value in these names, but given that tradition valuations don’t work (Netflix is valued at 20 times sales; the S&P is 1.7 times), investors start to see the upward momentum in these names sag, and then quickly exit as fast as they got in – Morgan Stanley points out that a basket of stocks consistent with hedge-fund overweights lagged a basket of HF underweights by 7.7 percentage points from March through April 4. There’s a point where these stocks become “broken” – and it can take several attempts before it happens, as it did in the dot-com era, but once it happens, there’s little real way to stop it. The average price paid by investors in a lot of these names ends up being higher than where the stock is at a given point, and that acts as a ceiling on a rebound. A few stocks escape this, but many don’t.

MORNING BID – The Cleveland Administration in the market

Apr 2, 2014 13:43 UTC

It took the market a little while to get the full measure of the day’s biggest economic news. (And no, it wasn’t the shout-fest on CNBC that seemed to have resulted in the delaying of an IPO and one of the first real reckonings among many people about the ramifications of high-frequency trading.)

But it seems to have truly settled in now: Car sales were up big in March, to a seasonally adjusted annual rate of 16.3 million units. That’s better than expected, and it’s one of the first big data points that lends credence to the idea that there was a real constraint linked to winter weather that was the worst in about 13-14 years.

With all things market related, it’s the future that matters, and that’s what allowed the S&P to push past its most recent level for its first close in the ‘Grover Cleveland administration,’ as blogger Eddy Elfenbein pointed out, pushing past Chester A. Arthur for the first time (that’s 1885 – this is a bit too ridiculous to further, so I’ll stop here).
The gainers were once again, technology, with an odd mix of leadership between a few big momentum favorites turning it back around again (Priceline, TripAdvisor), and some older tech names getting a bit of a boost like Cisco Systems, helped by it being its ex-dividend day, and Hewlett-Packard, which is just sort of old.

And that kind of puts us at a crossroads. Michael O’Rourke of JonesTrading suggests we could see a breakout after a month of churning in this market, though it’s possible the day’s gains came from some beginning-of-month flows into equities as investors allocate funds in that direction. ETF flows per Credit Suisse show lots of money headed in the direction of large-cap stocks – $6.4 billion out of the $7.5 billion on the week – with the biggest outflows out of healthcare ETFs, not exactly a surprise given the selling in biotech last week.

Now then, on the high-frequency trading (HFT) issue. Felix Salmon points out that the fervor over Michael Lewis’s book comes at a time when HFT action has diminished somewhat and the money being made isn’t what it was a few years ago.  But critical mass takes a while on these things, and a Lewis book seems to have turned out to be a catalyst for discussions of both the fairness question and how it relates to the underlying technology: Is this skimming or the way these firms provide liquidity (though one would argue who has asked them to act as an intermediary in some of these cases).

It seems to have thrown a monkey in the wrench of Virtu Financial’s IPO as well, at least for the time being. The times have changed – when smaller shops were doing the bulk of this activity and hitting other banks in their prop trading operations, it seemed like it was in a weird area and the nebulous definitions of what HFT did in the market didn’t move anyone to act, despite books from the likes of WSJ’s Scott Patterson or others. Things seem to be moving another direction now — and the old defense, that the HFT world provides liquidity and is totally benign (or worse, the knee-jerk “free markets gotta be free” assertion), isn’t enough. Institutions may be the ones most affected, and the concerns people have are there even if, as Salmon notes, the idea that Greenlight’s David Einhorn qualifies as the “little guy” doesn’t quite pass muster.

MORNING BID – $4 trillion, through the eye of a needle

Mar 28, 2014 13:19 UTC

The shift in the stock market away from momentum names and toward value is encouraging at least in some sense because it points to an ongoing appetite for equities rather than a reduction in interest there. However, one has to add the caveat that the Federal Reserve is still very much a part of this market, even as it diminishes its footprint.

The $55 billion in bond buying per month definitely continues to underpin rates and keep funding costs low for companies. Still, the market has reduced its reliance on the central bank and yet bond yields continue to sink, at least in the long-dated part of the curve, where the 30-year note neared 3.50 percent and the 10-year came close to 2.60 percent yet again.

The immediate expectation would seem to be for still-higher rates, particularly in the short end of the yield curve, where investors would be thought to trim positioning as the yield curve flattens. The market-implied rates suggest bonds are still a ways behind where the survey expectations are for the Federal Reserve – a two-year rate of just 0.45 percent will do that.

On the other hand, Citigroup analysts point out that the Fed has been consistently overestimating inflation and growth, and the Fed continues to want to adjust its target for when it will start raising rates, moving most recently from “definitely when unemployment hits 6.5 percent!” to “definitely when we say so, based on lots of indicators or something!” So maybe it’s not an underestimation so much has it is prudence. And those expecting more curve flattening, that is, buying in the short end and selling in the long end, would be ignoring that forward rates – the market’s expectations for rates going out into the future – already imply substantial flattening out (47 basis points between the 10 and 30, compared with 56 basis points in June 2004 when the Fed last began rate increases).

What’s that make out as? Essentially, Citigroup things it’s not a given that the short end will continue to sell off in a rapid fashion, but that things might take time, and the market is already on some levels pricing in a rate increase. So the slow unwind of the most accomodative monetary policy ever has begun, and it’s starting to show in rates markets, if not equities. Reducing or rolling off this $4 trillion balance sheet is threading the smallest needle in history will be quite the feat, if it can be done without more major shocks.

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