Stocks positioned in the developing world performed well last year, but this year “a vicious rotation has gripped markets” and “there has been an aggressive rotation out of growth and momentum shares into value stocks,” according to a report from top European hedge fund, TT International.
TT International – Vicious rotation: Former market leaders fall nearly 25%
The TT International DB Platinum Fund, a multi-asset class global macro fund with $1.2 billion under management, was down -0.50 percent in May and is down -3.79 percent year to date. TT European Long / Short fund was down -1.97 percent in May and is down -3.27 percent year to date.
TT International noted the stock rotation is occurring in former market leaders, including selling US biotech and Internet stocks, which have fallen nearly 25 percent from their early year highs. In Europe, a reversal of momentum stocks has taken place. The one time highest flying momentum stocks than the lower priced momentum stocks with valuation based on price to book ratio.
TheTT International DB Platinum fund found positive contributions from the long side of the energy sector, in particular General Electric Company (NYSE:GE) and BG Group plc (ADR) (OTCMKTS:BRGYY) (LON:BG), as well as the technology sector and consumer discretionary stocks. The fund engaged in currency trading and found success in a short EUR/USD position and shorted the Euro relative the CAD for diversification. In terms of portfolio position foreign exchange was the most significant exposure, with 69.3 percent of the portfolio while equities represented just over 30 percent.
The TT International European fund found success in Babcock International Group PLC (LON:BAB), coming off a successful investor rights issue; RTL Group SA ADR (OTCMKTS:RGLXY) (EBR:RTL), which exhibited a good recovery after the sell-off; GDF Suez SA (EPA:GSZ) (OTCMKTS:GDFZY), which benefited from re-rating of utilities as sovereign yields fell, and BG Group, whose change in senior management was well received. They had shorted mining stocks which benefited from declining commodity prices. On the negative side the fund experienced losses in index futures in the Euro Stoxx 50 and DAX, as well as a Spanish bank that found difficulty.
TT International’s top long holdings
In the European fund the top long holdings were Peugeot SA (EPA:UG) (OTCMKTS:PEUGY), GDF Suez SA (EPA:GSZ) (OTCMKTS:GDFZY), E.ON SE (FRA:EOAN) (OTCMKTS:EONGY), ING Groep NV (ADR) (NYSE:ING), Beiersdorf AG (FRA:BEI) (OTCMKTS:BDRFF) and Credit Suisse Group AG (ADR) (NYSE:CS). The fund was generally short Spanish and German financials.
The choppy conditions in equity markets, the report noted, have been caused by a perfect storm of full valuations, overcrowded positioning and ominous bond market behavior. “Developed market equities were beginning to look fully valued, particularly in the US,” the report said. “With a growing sense of unease about valuations in such high-flying concept stocks, there has been profit-taking in many of 2013’s best performing stocks and sectors, initially in the US and later in Europe and the UK. This helps explain an element of the rotation –winners have been sold and underperformers bought.”
TT International – Stocks are in a maturing investment cycle
The report thinks stocks are in a maturing investment cycle, with many positions “increasingly overcrowded,” which led to a trickle of selling quickly turning into a flood. The report thinks the rotation is a “temporary repositioning and derisking, a necessary period of consolidation following last year’s impressive rally.”
The report noted dark omens on the horizon, however, including the May drop in US bond yields and falling German Bunds. “This trend has surprised many investors who expected a robust US recovery, combined with the steady reduction in the Federal Reserve’s bond-buying, to cause yields to rise,” the report said.
The report pointed to potential a deflationary trend emerging, as Europe appears to be entering “a twilight zone of ultra-low inflation and is one shock away from outright deflation.” Stripping out one-off austerity-driven tax hikes, the report notes that 23 out of 28 countries in the EU have been in outright deflation since mid-2013.
The report concludes that fears over the bearish messages being conveyed by lower bond yields are likely to prove exaggerated, prolonged volatility could exist as liquidity had dried up but overall they see a gradually improving global economic environment will benefit investors but natural stock rotations and valuation flows will continue.