The market narrative in and around the October bond rout (first) and equity selloff (the following week), centered on a rather dramatic rotation from Growth to Value.
Naturally, that rotation was accompanied by a momentous Momentum (pardon the pseudo-pun) unwind or, more simply, an especially ugly drawdown in what amounts to a pure play on Long Growth/Short Value.
There were a number of plausible explanations for that rotation, one of which was that because the somewhat anomalous late-hiking-cycle bear steepening episode was seemingly prompted by further evidence of U.S. economic outperformance, everybody hit the exits on “slow-flation” plays.
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Whatever the case, here’s a simplistic visual representation (note that the red annotation marks the week before the October 10 crash, highlighting how the Growth—> Value trade set the stage for the Momentum unwind):
Given that, and given the rather precipitous plunge in equity Long/Short funds’ rolling beta to the S&P that unfolded during the first half of October, one was left to speculate that hedge funds might have been caught wrong-footed after taking up their exposure in September (i.e., after grabbing for exposure after the rally ran out ahead of them in August).
That’s the context for a new note from JPMorgan, which outlines the extent to which the bank’s Prime Finance clients (i.e., hedge funds and institutions, both discretionary and systematic) did indeed rotate out of Growth and into Value this month.
The bank starts by noting that the Long/Short ratio for North American equities fell more sharply than that for EMEA or Asia-Pacific equities, which underscores the U.S.-centric nature of the rout.
“As a result our clients have shifted to the most underweight stance in US vs. non-US equities since last January”, JPMorgan says.
(JPMorgan)
On the rotation point mentioned above, the bank writes that “across sectors the position reduction on US equities in October was concentrated in Consumer Discretionary and Industrial sector stocks [and] across styles the position reduction on US equities was concentrated in Growth stocks.”
(JPMorgan)
Naturally, that was beneficial to Value. JPM also notes that “previously beaten up US Importers” got a boost from “new” NAFTA.
So where does that leave us? Well, according to the bank, “Consumer Discretionary is the most underweight sector among US sectors and Growth stocks the most underweight style.” Folks are still long Tech, but JPM reminds you that position has “been declining steadily after peaking two months ago.”
(JPMorgan)
Is this a contrarian indicator in the short-term? Or, more to the point, now that the bank’s clients are the most underweight U.S. shares since January and now that Growth is suddenly out of favor, is it time for a snapback to what “normally” works?
Suffice to say when backtested, the results suggest using this data for contrarian indicator purposes is mixed.
They will chase any performance as many face an existential threat. I am guessing we will see the usual suspects reassert themselves in a performance grab into y/e. the battle between slowing growth, tougher compares, higher rates but we see lower, and more reasonable valuations combined with the end of the momo quant issues and settled elections and some hope on China trade will make for an interesting few months……….