Hedge Funds And Mutual Funds Are “Clashing” On Financials
After the weaker than expected nonfarm payrolls in May – 138,000 new jobs were created after a revised lower 174,000 number was posted in April – Goldman Saks Chief US Equity Strategist David Kostin is more convinced of a rate hike in June. But perhaps most meaningful is what happens in September as it relates to the US Federal Reserve balance sheet. The predicted Fed move to announce plans for balance sheet reduction has potential to influence a popular mutual fund holding – a stock sector holding that hedge funds have since generally dismissed.
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How do markets react when interest rates are rising and the Fed is unwinding its balance sheet?
With a $4.6 trillion balance sheet, the talk among Fed watchers that sometimes stays off the official radar wonders how the balance sheet will be managed? Did central bankers have an investment exit strategy and calculate the different risk management probability paths when they started down the artificial stimulus path? If central bankers decide to unwind their historic balance sheet, the meaningful question is what might result from the correlated impact on supply hitting markets as interest rates are rising?
In a June 2 US Weekly Kickstart publication, Kostin and his team make a one sentence prediction that has potential to impact financials to a significant degree. When forecasting that the US Federal Reserve might unwind their wound tight balance sheet, starting with an announcement in September, this is answering the whisper question.
In the past, fund managers have been watching the unwinding of dependent stimulus and modeling various probability paths. In part, this talk was evident in 2015 when certain hedge funds were discussing probability paths relative to a delicate unwind and got neutral the market before this occurred.
This is a surgery where success is not heralded in news headlines.
Chair Janet Yellen is successful at eliminating the dependency of stimulus and unwinding the unprecedented Fed balance sheet, that success will be measured by the lack of news about it. The economy will keep on running without a hitch and Yellen, the first female Fed chair, will likely not receive much acclaim outside of knowing professionals. In particular, certain analysts will keep an eye on the reaction along the yield curve as both interest rates are rising and a potential source of supply – the Fed balance sheet unwind – hits markets.
In particular, certain analysts will keep an eye on the reaction along the yield curve as both interest rates are rising and a potential source of supply – the Fed balance sheet unwind – starts to hit the markets.
If Goldman's September’s unwind announcement forecast is correct – and the subtle and typically well-informed investment bank making the prediction is often cognizant into the nuanced communication of the Fed – then how that announcement is crafted and the details of the unwind in September have potential to be market moving.
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Watch the financial sector, as hedge funds and mutual funds are "clashing"
The interest rate complex is typically a performance driver of financial stocks to various degrees. On a basic level, brokerage firms generate a percentage of their revenue dependent on prevailing short term rates as do banks -- impacting global banks engaged in OTC trading differently than community banks doing lending. A move higher in interest rates will even benefit returns of hedge funds to certain degrees, particularly those that can post margin and collect interest income on assets they pledge towards derivatives investments.
Financial stocks are part of a holding trend that Goldman noted was the source of disagreement. While both hedge funds and the more retail focused mutual funds have been positively exposed to the Information Technology sector, they differ over exposure to financials.
Financials have been a manic-depressive stock category, climbing to new heights and then finding gravity in the relatively short period of time between the US Presidential Election and present.
Hedge funds are not buying the argument for financials, a view that Goldman notes is “clashing” with mutual fund managers. Financials are the hedge fund’s most underweight sector relative to the Russell 3000, but it is the second-most overweight sector in mutual fund portfolios.
The fate of this investment positioning, in part, could find clarity depending on what the Fed does and does not say in September.
Disclosure: This article is NOT an investment recommendation, please see our disclaimer - Get our 10 ...
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