Hedge Fund Playground Is Bound to Refill the Sand Box

There were six words near the top of Gina Martin Adams’ strategy note this morning that should be music to the ears of stock pickers: “ultimately dispersion among sectors should rise.”

Wells Fargo & Co.’s equity strategist was referring to the variance in returns among stocks. Goldman Sachs Group Inc.’s David Kostin referred to the same thing in May as the “opportunity set, the sand box, the swimming pool” which had grown so small that hedge funds were having a hard time building sand castles or doing cannonballs (or whatever you’d care to imagine them doing in metaphors like this).

Consider the 10 main industry groups in the Standard & Poor’s 500 Index. Through last week, health-care stocks were up less than 9 percent as a group for the best performance. Consumer discretionary companies were down less than 0.8 percent for the worst performance, leaving the spread between the leaders and laggards at 9.7 percentage points.

Compare that to the sand box where hedge funds and other investors played in the past: The year-to-date dispersion was 21 percent through Aug. 8, 2013, and 42 percent in the same period of 2009, according to data compiled by Bloomberg. In fact, this year’s spread is the narrowest in data going back to 1990. It’s less than a third of the average dispersion of the 10 groups in those 24 years, the data show.

“As the market normalizes with Fed policy, volatility may stay elevated, but ultimately dispersion among sectors should rise,” Martin Adams predicted in the report.

Break Dance

She sees the wider dispersion going something like this, with “breakouts,” “breakdowns” and “breakups” worth playing:

Metals and mining companies are poised for a “breakout” this month after years of underperformance and Wells Fargo has upgraded its rating on the group to market weight from underweight.

The “breakdown” group consists of machinery, building products and homebuilding stocks as falling crop prices and weakening housing data weigh on the group, in which Martin Adams advises cutting or altering positions.

And finally, the “breakup” group is technology, where there is something for everyone, according to the Wells Fargo strategists: “Industry level details continue to support our case for a marketweight of software and underweight of services within our overweight recommendation for the tech sector.”

Anyway, as the great strategist Tom Petty once wrote of breakdowns: We’ve said all there is to say.

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