The UBS proprietary institutional flow data indicates that hedge funds are increasing exposure to financials and decreasing exposure to health care. Given that health care has outperformed significantly year to date, hedge funds that are “lightening up” on health care exposure could signal a year-end rotational move. The hedge funds could be coming out of the high-flying stocks and sectors and into underperformers. Credit Suisse recently reported hedge fund rotation out of high flyers in to international stocks. The top funds have also continued to flow into the energy sector despite falling oil prices.
Hedge funds are moving their money toward the financial names that are benefiting from the slow but sure economic expansion. They also are placing bets on the stocks that continue to benefit from strong equity market gains and an increasingly robust investment banking sector. The stocks seeing the most interest may include Citigroup Inc. (NYSE: C), Morgan Stanley (NYSE: MS), Goldman Sachs Group Inc. (NYSE: GS), Bank of America Corp. (NYSE: BAC) and J.P. Morgan Chase & Co. (NYSE: JPM).
Hedge funds flows are also going toward the energy sector, despite crude prices that fallen to their lowest levels in almost a year. The rationale for the rotation appears to be a belief that energy companies are ready to challenge the restrictions on crude exports after huge increases in domestic production. They may argue that limits designed to keep petroleum in America may violate international trade rules. The top energy names seeing interest from hedge funds may include Exxon Mobil Corp. (NYSE: XOM), Chevron Corp. (NYSE: CVX), Pioneer Natural Resources Co. (NYSE: PXD), Occidental Petroleum Corp. (NYSE: OXY), EOG Resource Inc. (NYSE: EOG) and Anadarko Petroleum Corp. (NYSE: APC). Oil Services giants Schlumberger Ltd. (NYSE: SLB) and Halliburton Co. (NYSE: HAL) may also be attracting hedge fund inflows.
The top biotech and health care names that could see selling pressure are the momentum stocks and large cap leaders that have seen huge gains this year. They include Biogen Idec Inc. (NASDAQ: BIIB), Regeneron Pharmaceuticals Inc. (NYSE: REGN), Amgen Inc. (NASDAQ: AMGN) and smaller names like Questcor Pharmaceuticals Inc. (NASDAQ: QCOR) and Medivation Inc. (NASDAQ: MDVN).
The stock market rally, especially in the technology names, is starting to draw comparisons to the rally of 1999, which ultimately led to a tech bust and disaster. The difference this time, which is always a no-no on Wall Street, is valuations. The S&P 500 is currently trading at about 16 times forward earnings. That number is way up from the 2009 trough, but nowhere near bubble territory. The top portfolio managers at hedge funds are making bets that the market rally could continue, even if a sizable correction is tossed in. By rotating to names that are more reasonable, they may be set up to catch a continuation of the rally in 2014.