Hedge funds did something highly unusual during the market's recent meltdown - and it's a great sign for stocks
- During the recent correction, losses in the stocks most popular with hedge funds were muted, relative to the broader market.
- Goldman Sachs argues this is a positive sign for the health of the market, since it means the selloff was likely spurred by technical factors, rather than fundamentals.
Moves in stocks that are the most popular with hedge funds have historically been an exaggerated version of the broader market, for better or worse.
When the equity market falls, hedge fund favorites tend to take an outsized beating, and vice versa. Which is why the group's performance was so surprising as the S&P 500 suffered a 10% correction earlier this month. Theoretically, it should've gotten smoked.
But the Goldman Sachs Hedge Fund VIP index - which consists of the 50 stocks that matter most to 808 hedge funds with $2.1 trillion under management - actually outperformed the benchmark during the turbulent period, according to the firm.
And while hedge funds are surely feeling like they dodged a bullet, the wider-reaching implications of their shocking resilience should also have them excited.
"The outperformance of the most popular hedge fund positions during the recent correction underscores the technical nature of the drawdown and the resilience of investor sentiment," a group of Goldman strategists led by Ben Snider wrote in a client note.
Put differently, the relatively muted losses in popular hedge fund holdings suggest the correction was based on something other than the core fundamentals that usually dictate market action. And that's great news for equities going forward.
The VIP index's lack of downside participation during the selloff has it up 4% year-to-date, roughly double the S&P 500, according to Goldman. As such, the group represents one of the most successful long positions in the market in 2018, as the chart below shows.
The composition of Goldman's VIP basket also suggests the basket could continue to outperform. As of year-end 2017, tech stocks had the largest net portfolio weighting out of any sector.
The industry is expected to see earnings growth of 31% in 2018, a full 10 basis points more than the S&P 500. And considering profit expansion has been the foremost driver of gains throughout the nine-year stock bull market, the rest of the year looks bright for the tech sector, and by extension hedge funds.
That said, fund managers don't seem content with their tech holdings, and are continuing to pile in. They've poured roughly $10 billion into the sector over the past three months, the most since at least 2005 for a period of that length.
It remains to be seen whether or not this boldness will end up backfiring. If popular hedge fund holdings resume their historical "high beta" role, declines could get messy for the VIP index the next time the market gets rocked.
