Day Traders Buy the Dip in Cyclical Trade That Hedge Funds Shun

(Bloomberg) -- With airlines and travel-related stocks slumping on fears over a fast-spreading Covid variant, U.S. day traders are staging another clash with hedge funds on the reopening trade.

The retail crowd bought the dip, snapping up shares of hotels, casinos and cruise lines on Monday at the fastest pace in a year, according to data compiled by Vanda Research that tracks traffic on retail trading platforms and industry-wide order flows.

At the same time, professional speculators are trimming bets that depended on economic recovery. After selling travel and leisure shares, hedge funds’ net exposure to cyclical stocks last month fell to the lowest level since late 2020, data from Morgan Stanley’s prime broker show.

While the face-off may reflect opposite views on how the economic recovery will play out, Michael Purves at Tallbacken Capital Advisors said that it could also be driven by hedge funds’ needs to keep risk under control. In other words, when some money-losing stocks threaten performance, fund managers could be forced to liquidate the positions.

“What’s being really revealed is, that investment flexibility of not having to worry about the style drift or being stopped out is an enormous advantage,” Purves said by phone. “There is a wide range of opinions as to how much more you want to be long cyclicals or reflation. The discussion is going on but I think a lot of people still think we’re not in the ninth inning of this, we’re in the fourth inning of it, and they want to stay in the trade.”

The reopening trade took a beating last month as the Delta variant fueled an increase in Covid-19 cases from the U.K. to India. Airlines, for instance, tumbled about 10% as a group for the worst month since March 2020. A Goldman Sachs Group Inc. basket of stocks that are poised to benefit from a return to normal economic activity lost 4%, the most since September.

Often seen as momentum chasers, the army of day traders are instead now going bargain hunting. In the second half of June, they scooped up shares that trailed the market -- energy, materials, financials and industrials, according to data from Vanda. Technology -- the best-performing in the S&P 500 Index -- saw its share of single-stock purchases falling to the lowest level in more than a year.

By contrast, hedge funds have preferred resilient growers such as tech since mid-May and turned net sellers in value stocks, a cohort dominated by cyclical shares, client data from Morgan Stanley show.

It’s the latest example of the conflict between amateur and professional investors in the pandemic era. At the market’s bottom 15 months ago, retail money quickly embraced the reopening trade, while pros were slow to dive in. In January, the hedge-fund industry was forced to retreat from the market after the army of day traders banded together to target the most-shorted stocks.

For now, big players are having the upper hand. As Federal Reserve policy makers indicated a hawkish shift, sparking concern that the central bank may not let the economy run too hot, the reflation trade started to show signs of cracking. The Russell 1000 Value Index trailed its growth counterpart by roughly 8 percentage points in June, the most in two decades.

“At the root of this shift in behavior there is a major institutional reallocation out of value and reopening into tech; a similar situation to Q2 2020,” Vanda analysts Ben Onatibia and Giacomo Pierantoni wrote in a note. “Retail investors are now liquidity providers rather than the marginal prices setter.”

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