Watch this video to see why mystudents and I are banking in the first few weeks of 2014, I’m already up nearly 50%!
But what about longer term investments?
Bank of America publishes an equity client flow trend report, and the last one shows that basically everyone is buying cyclicals…except hedge funds (aka the so-called smart money), who are selling everything. The Reformed Broker was kind enough to post it on his blog.
While hedge funds have been net sellers for the second week in a row, everyone else is buying cyclicals.
Investopedia defines cyclicals as: A type of an industry that is sensitive to the business cycle, such that revenues are generally higher in periods of economic prosperity and expansion, and lower in periods of economic downturn and contraction. Companies in cyclical industries can deal with this type of volatility by implementing cuts to compensations and layoffs during bad times, and paying bonuses and hiring en masse in good times. Cyclical industries include those that produce durable goods such as raw materials and heavy equipment. These stocks rise and fall with the business cycle. This seeming predictability in the movement of these stock’s prices leads some investors to try to time the market by buying these stocks at the low point in the business cycle and selling them at the high point. Examples of companies whose stocks are cyclical include car manufacturers, airlines, furniture retailers, clothing stores, hotels and restaurants. When the economy is doing well, people can afford to buy new cars, upgrade their home furnishings, go shopping and travel.
Defensive stocks are those that provides a constant dividend and stable earnings regardless of the state of the overall stock market. This is not to be confused with a “defense stock”, which refers to stock in companies which manufacture things like weapons, ammunition and fighter jets. Defensive stocks remain stable during the various phases of the business cycle. During recessions they tend to perform better than the market; however, during an expansion phase it performs below the market. Betas of defensive stocks are less than one. The utility industry is an example of defensive stocks because during all phases of the business cycle, people need gas and electricity. Many active investors will invest in defensive stocks if a market downturn is expected.
Flows are rotating away from defensives and “bond-like stocks” with a clear favoritism for cyclicals, which Bank of America says should persist into 2014 as economic growth picks up. When people expect the economy to recover, they buy riskier assets like stocks, and when they are more bearish on the economy, they buy safer assets like bonds.
This is part of the report from Bank of America’s Jill Carey, Savita Subramanian and the rest of their team:
Weekly flows by sector, client & size (1/6-1/10)
Clients kicked off 2014 as broad-based net buyers of all 10 GICS sectors last week, led by Tech and Health Care; only ETFs saw net sales.
Side note, GICS stands for Global Industry Classification Standard. It is an industry taxonomy developed by MSCI and Standard & Poor’s (S&P) for use by the global financial community. It consists of 10 sectors, 24 industry groups, 68 industries and 154 sub-industries into which S&P has categorized all major public companies.
While flow trends have suggested a preference for defensives over cyclicals, last week’s flows show the reverse, as the bond proxies of Telecom and Utilities—which were the only two sectors to see inflows in 2013—saw the most muted net buying of the 10 sectors.
And four-week-average flows into cyclical sectors turned positive for the first time since mid-October. We expect clients will rotate out of defensives and into cyclicals as growth reaccelerates in 2014.
Private clients led net buying, and have now bought stocks in all but 3 of the last 33 weeks since late May. Institutional clients were also net buyers for the fourth consecutive week, while hedge funds sold stocks for the second week in a row. All three size segments saw inflows, led by small caps.
Here’s what last week’s activity looks like vs the four-week average for context (the swing in materials and small caps should be grabbing your attention, as should the abandonment of ETFs):
Broad-based net buying kicks off 2014
As you can see, hedge funds sold even more than their 4-week average, roughly $700 million. On the other hand, you have private clients buying more than their 4-week average, at roughly $1 billion. Institutional clients were still buyers, but they pulled back a bit from their average at about $500 million.
So who is right? Only time will tell. Hedge funds didn’t have that great of a year in 2013. Maybe their luck will change, maybe it won’t. When the market is at an all-time high, it’s really hard to know what to do. Investors don’t want to miss out on another leg up, but all should be weary of getting in at the top, precisely the wrong time to buy.
Thankfully for myself and my students, our profits aren’t directly tied to how large companies and the market is doing overall. They can make money in any environment. When the market is doing well, crappy penny stock companies pay more, and more often, to pump up their stocks and they have a greater potential to run and go higher than in a down market. When the stock market isn’t doing well, chances are that there will be a larger pool of stocks worth shorting, again netting us solid profits.