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Stock market turmoil creates crucial situation for group of investors


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  • Active managers have been regularly criticized as
    outdated during the past few years as passive investing has
    exploded.
  • Wall Street is suggesting that so-called stock pickers
    could be due for a renaissance, especially given turmoil in
    equity markets, which has created opportunities for active
    investors.

Active managers have heard it
all.

They’ve absorbed criticisms that their investment style is
outdated. They’ve suffered the indignity of having market pundits
question their worth. They’ve seen investors flee their
funds for exchange-traded funds and
other passive vehicles. 

Now, following years spent battling in the court of public
opinion, it’s time for these so-called stock pickers to put up or shut up.

At the core of their newfound urgency is a stock market landscape
that was recently rocked by its toughest stretch in years. The
turbulence disrupted a serene environment marked by the lowest
volatility on record, stirring
up market dislocations that should represent opportunities for
investors who primarily trade on company fundamentals.

But don’t take our word for it. Firms all across Wall Street are
signaling a stock-picking renaissance.

Take Jefferies for example. The firm is focused on climbing
inflation, which it says could
result in a rocky road for equities. It identifies the resulting
upward shift in bond yield curves as a positive for active
managers, relative to their passive peers.

“Passive investing suited a dis-inflationary world given that
real rates were deeply negative, underwriting virtually all asset
classes,” Sean Darby, the firm’s chief global equity strategist,
wrote in a client note.

Darby also notes that higher inflation is “not good for all parts
of the equity market,” highlighting bond proxies like consumer
staples and utilities as those most likely to struggle. It’s
precisely that kind of selective bearishness that allows active
managers to prove their bonafides in a fragmented market.

Don’t believe Jefferies? Well, Goldman Sachs has reached a similar
conclusion, citing stock pickers who are already faring quite
well amid considerable market turmoil.

Stock indexes that contain the most popular holdings for hedge
funds and mutual funds — perhaps the two most prevalent groups of
active managers — outperformed during the equity selloff last
week, according to Goldman data. The firm also says that most
conversations it’s had with clients revolve around what to buy,
rather than what to offload.

Off to a strong start in 2018

The improvement in stock-picking conditions comes at a great time
for active investors, who were fresh off their best month in
years when the equity correction created even more opportunities.

Out of all large-cap fund managers, 69% beat their benchmarks in
January, the highest monthly hit rate in six years, and the
second-highest on record, according to Bank of America Merrill Lynch
(BAML) data.

That strong performance isn’t particularly surprising when you
consider the rosy full-year outlook provided by Bernstein. The
main focus of the firm’s bullish forecast was intra-stock
correlation, which is something that can dictate just how many
single-stock opportunities there are for investors.

“Stock correlations have fallen dramatically,” Bernstein
strategists led by Alla Harmsworth wrote in a February 5 note.
“This suggests a heightened potential ability to identify
idiosyncratic ‘winners’ even amongst peers within narrow market
segments. This potential is further reinforced by the fact that
valuation spreads remain wider than usual not just across the
whole market, but within sectors and industries too.”

Morgan
Stanley
agrees that no stock-picking environment is
truly complete without a tangible breakdown between individual
stocks — one it says is happening right now.

According to the firm’s data, stocks are trading independently of
one another to a degree not seen since the height of the tech
bubble. As of year-end 2017, 71% of the risk associated with
the average S&P 500 stock was
unexplainable by a set of six macro risk factors maintained by
Morgan Stanley over the prior 252 days. That’s the highest in
almost 17 years.

With all of these positive factors in mind, and with data
suggesting that investors are seeking out single-stock
investments, active managers are proving their worth to start
2018.

Now the pressure is on to keep it up and prove that it’s a
sustainable trend, rather than a one-off occurrence.


Screen Shot 2018 01 09 at 3.19.40 PM
High intra-stock correlation means ripe conditions for
stock-pickers.

Morgan
Stanley



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