(Bloomberg) – Frenzied retail purchases catapult stock benchmarks to records. A handful of mega-corporations dominate, warning of nosebleed ratings daily. Suddenly a rotation sets in, reviving lagging industries while crushing the broader market.
The 2021 setup in stock? Could be. These are the same circumstances investors faced two decades ago when the bursting of the dot-com bubble on the S&P 500 and the Nasdaq 100 triggered a prolonged swoon. One less discussed aspect of this episode is that it turned out to be a good time for stocks. Choosing hedge funds whose ability to handle three years of volatility could be a blueprint for success today.
While rotations have stalled in recent months, industry leadership is once again being questioned. Democratic wins in the Senate runoff elections raise bets on economic stimulus, even if rising rates hamper highly valued tech companies. Small-cap stocks rose nearly 6% over the past week, outperforming the Nasdaq 100 the most in two months. A version of the S&P 500 that eliminates market value distortions and loosens the grip of the faang block at one point rose four times as much as the cap-weighted gauge.
“If you lean into the right sector just a little over the coming months, you can add significant value over passive ones,” said Rich Weiss, chief investment officer, multi-asset strategies, American Century Investments. said by phone. “A big turning point is coming that will make active managers stand up to it.”
Improving the market breadth has proven itself in the past for stock pickers, regardless of the general direction of the market. Between 2000 and 2002, when the S&P 500 fell at least 10% for three consecutive years, speculative money managers who place bullish and bearish bets have done well with their clients. The industry grew in the first two years – up 9% in 2000 and 0.4% in 2001, according to Hedge Fund Research. In 2002, when their returns turned negative, the 4.7% loss was only a fifth of the market loss.
Short positions helped hedge funds cushion the downtrend while the market was in free fall. Also in their favor was a growing pool of winners. While the S&P 500 fell in 2000, its equally weighted version rose nearly 8%.
With long-only funds, broad profits tend to support returns as well. Take 2009, the only year in which the average stock outperformed 2000. That year, only 40.7% of equity funds lagged the benchmark, a decade low, according to S&P Dow Jones Indices.
A market rally wider than 10 or 15 stocks “is beneficial to managers,” said Brent Schutte, chief investment strategist at Northwestern Mutual Wealth Management. “No active manager is likely to outweigh all of these stocks as much as is required in such an environment. The expansion opens up more performance options. “
Of course, what is happening now is not what happened 20 years ago in terms of severity. Back then, technology was at the center of an epic breakdown triggered by the disintegration of investments in unprofitable companies. Today the country is recovering from a pandemic-triggered recession. Rather than shrinking like they did in 2000, computer and software company profits defy broad decline and expansion.
Still, there is still the possibility that a handful of market giants will loosen their grip. When the Georgian Senate runoff raised expectations that the Democrats might step up incentives and tighten regulation, four of the Faangs fell, wiping out the $ 75 billion total. Meanwhile, the KBW Bank Index rose nearly 9%, while the energy shares of the S&P 500 as a group rose 9.3%.
While a week is hardly a sign of a lasting trend, it at least gives hope to the stock pickers who have been bullied by stay-at-home trading. Due to the rotation, the S&P 500 Equilibrium Index increased 2.9% compared to a 1.8% increase in the traditional measurement.
Last year was a bad year for active investing, with only 37% of S&P 500 stocks outperforming Broad Gauge, the lowest percentage since 1999, according to data from Bank of America Corp. showed. Less than 20% of large-cap core funds outperformed their benchmark compared to 28% last year.
A rapid rotation of tech mega-caps would be welcome news for active managers who, for the most part, don’t own enough Faang stock to keep up with the benchmarks. Of the roughly 200 funds compared to the S&P 500 with assets of at least $ 500 million, those with at least a fifth of their money are with Facebook Inc., Amazon.com Inc., Apple Inc., Microsoft Corp. and Alphabet Inc. have returned an average of 24% over the past 12 months. That means a 17% gain for those who don’t have a stake.
Earnings from value stocks and small caps could provide tailwinds for active funds by increasing the number of potential earnings stocks after a year in which half of the S&P 500 advance was due to five tech mega-caps. According to the Leuthold Group, less than a third of the companies in the S&P 1500 Composite exceeded the S&P 500 on a 12-month basis by November. That proportion should double in the coming year, the company’s chief investment officer, Doug Ramsey recently wrote.
“Broad market outperformance doesn’t always mean big market gains, but active managers cheer,” Ramsey said in an email on Wednesday. “The percentage of stocks that are outperforming is still very low, and I still think it will explode.”
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This article originally appeared on finance.yahoo.com
