A successful strategy to avoid the worst of this year’s equity retreat: ask your analyst what to buy and sell, then do the opposite.
The stocks most beloved by strategists around the world, from U.S. gamemaker Activision Blizzard Inc. to Chinese electrical appliances maker Midea Group Co., have fallen 11 percent in 2016 on average. Companies ranked at the bottom of the heap by analysts are down 3.4 percent, data compiled by Bloomberg show.
Popular companies are victims of their own success as investors sell winners to meet redemptions, says BNP Paribas Investment Partners. In the U.S., the unraveling of momentum trades has left hedge funds’ favorite shares trailing the Standard & Poor’s 500 Index by 4.6 percentage points in 2016, after outperforming by an average of 10 percentage points in each of the last four years, according to Goldman Sachs Group Inc. Deepening losses in stocks that were previously leaders of the pack are adding to pessimism as investors grapple with the first bear market for global equities in more than four years.
“When you have a risk reduction exercise like what we’ve seen, and good stocks get thrown out with the not-so-good, you really have to be confident of your fundamental analysts,” said Julian Emanuel, executive director of U.S. equity and derivatives strategy at UBS Securities LLC in New York. “These names in a former life would have been called growth at a reasonable price, and the question is if they’ve become unreasonable."
The MSCI All-Country World Index added 0.9 percent last week, paring its 2016 drop to 6.5 percent. The gauge fell into a bear market this month for the first time since 2011 as concern about China’s economic outlook and the collapse in oil prices drove a flight from risky assets. The index slid 0.3 percent as of 5:38 p.m. in Tokyo on Monday.
Losses have stretched around the world; among benchmark measures of the biggest markets, only those in Russia and Taiwan have eked out a gain. Against that backdrop, attributes favored by stock strategists -- for example, a track record of boosting earnings -- are becoming hallmarks of the shares that investors are finding easiest to sell.
“This year there’s probably redemption pressure on sovereign funds and mutual funds, so those stocks do face selling pressure," said Hong Kong-based Caroline Maurer, head of greater China equities at BNP Paribas Investment Partners. “Those stocks have done well the last couple of years. They tend to be more expensive and better owned."
The 50 most highly-rated companies with a market value of more than $5 billion and at least five analyst recommendations tracked by Bloomberg trade, on average, at 4.1 times the value of their net assets. Energy producers dominate the firms with the worst analyst ratings, which are priced at an average 2.2 times book value, data compiled by Bloomberg show.
Mikio Kumada, a Hong Kong-based global strategist at LGT Capital Partners, says analysts need time to adjust when market dynamics change. He cited March 2009, when they were bearish in what was, in retrospect, the ideal time to pile into equities.
“We’re certainly not in a robust bull market anymore since at least the beginning of this year," Kumada said. “So it will take time for the consensus rating to adapt to that."
While about one in three of the shares most favored by analysts are traded in Shanghai or Shenzhen, it’s not just Chinese strategists who are backing the wrong horses. If mainland stocks are removed from the study, the pattern still holds, with the top stocks sliding 6.2 percent on average versus a 2.6 percent decline by the lowest-ranked batch.
Hedge funds are hurting. Returns on shares they tend to avoid are beating the S&P 500 by 541 basis points this year as those they favor lag behind, according to data compiled by Goldman Sachs in a Feb. 22 report.
That’s partly because the managers themselves have been rushing for the exits, paring their bets on gains in equities to the lowest level since 2012, says Goldman. And investors pulled a net $21.5 billion from hedge funds in January, helping push assets managed by the industry below $3 trillion for the first time since 2014, according to data from eVestment.
Amazon.com Inc., on Goldman’s list of stocks that appear most frequently among hedge funds’ top 10 holdings, is down 18 percent in 2016 after more than doubling last year. Tenet Healthcare Corp., which tops a separate ranking of equities with the highest share of hedge fund ownership, lost 15 percent. The companies have a rating of at least 4 on a Bloomberg scale where 5 represents unanimous buy calls from analysts.
Midea, which every analyst tracked by Bloomberg advises purchasing, fell 18 percent this year. The company is China’s biggest manufacturer of consumer appliances, with a 17.1 percent market share in 2015, Euromonitor International data show. Activision Blizzard, which also has a perfect score from analysts, lost 18 percent in 2016. While the largest U.S. video-game maker reported fourth-quarter revenue and profit that fell short of analysts’ estimates, 18 strategists reaffirmed bullish recommendations since the earnings release.
The growing popularity of index-tracking funds is directing money out of shares that active managers and strategists typically favor, according to Chisato Haganuma, chief equity strategist at Mitsubishi UFJ Morgan Stanley Securities Co. in Tokyo. In 2015, passively managed stock mutual funds and exchange-traded funds collected $414 billion, compared with redemptions of $207 billion from actively-run ones, according to Morningstar Inc. data.
“It’s not that they’re trying to buy bad companies, it’s that they use completely different rules to select stocks," Haganuma said of passive funds.
Better earnings track records haven’t meant much this year: Chinese medicine maker Yunnan Baiyao Group Co., which has a buy rating from every analyst Bloomberg tracks, is down 22 percent even after reporting record profit. But at some point, investors will see the analysts’ picks return to favor, according to Ample Capital Ltd.’s Alex Wong, who helps oversee $100 million.
“Funds are going for companies that are looking cheap," he said. “But eventually fundamentals will favor growth stocks."
Over the last two years, the most-loved companies rose 42 percent on average, versus a 6.6 percent gain by the shares disliked by analysts. For BNP Paribas’s Maurer, that’s a reason to favor the underdogs.
“You can’t keep on chasing what’s already done well in the market," she said. “You have to think the other way around."