On November 29 and continuing during the subsequent three or four sessions, investors got a taste of what happens when there’s a sudden (possibly factor flow-driven) rotation out of the winners and into unloved names and sectors (of course “unloved” was a relative term in 2017).
The tech selloff that started on November 29 eventually culminated in the worst 5-day underperformance for the Nasdaq 100 versus the S&P since 2009. The impetus was initially written off to investors rotating into the presumed winners from the tax bill (i.e. not tech), but the indiscriminate nature of the move led some folks to posit that what we witnessed was a dress rehearsal for the type of “Factormaggedon” Goldman warned about over the summer.
“It seemed to be tax-related, but it was pretty extreme [and] to get such a rapid move on a particular day must be a function of flow,” SocGen’s Andrew Lapthorne told Bloomberg at the time, adding that “to get such a strong relationship between a factor and performance always seems a little bit smacking of systematic.” Here’s one illustration of that:
As we kick off the new year, BofAML’s Savita Subramanian is out warning about a dynamic that has the potential to trigger a similar shift out of crowded names and into neglected stocks. She pegs the episode mentioned above as an example.
“We already saw some of this trade shortly after the strong style reversal since Nov 27, when neglected stocks outperformed crowded stocks by almost a full percentage point over the next two weeks,” Subramanian writes, in a new note dated Tuesday, adding that “this spread was subsequently wiped out ahead of December 31, suggesting that crowding risks may remain ahead of the tendency for asset allocators and PMs to rebalance after year-end.”
Ok, so how big of a concern is this? Well, I guess that depends on your definition of “concerning” and of course on whether or not you’re actually exposed to this dynamic, but Subramanian notes that “based on our data since 2009, the 10 most overweight stocks have lagged the 10 most underweight stocks on average by 57bp and 117bp during the first 15 and 30 calendar days of the year, respectively.”
With that in mind, here are active manager sector weights versus a year ago…
And here are the current top and bottom 10 stocks by relative active fund exposure…
Make of that what you will.