(Repeating to additional subscribers)
By Ryan Vlastelica and David Gaffen
NEW YORK, March 28 Investors in some of the past
year's hottest U.S. stocks have been given a savage lesson in
the risks of so-called "momentum trading".
A group of 24 such companies compiled by Credit Suisse has
lost $63 billion in market value, or almost 19 percent, so far
in March. One of them, streaming video service Netflix,
has declined on 15 of the last 17 trading days, while another,
online travel service Priceline, is on pace to for its
worst month in nearly two years, while Twitter sank
below its November first-day closing price for the first time.
The sell off may well have further to go, investors warn.
For one thing, the initial public offering market looks
vulnerable after King Digital Entertainment, maker of
the popular Candy Crush online game, cratered on its debut,
losing 15 percent in its first day of trade on Wednesday, and
another 2.7 percent on Thursday. If such raisings get pulled or
pared back it will likely hurt the banks' underwriting fees.
But while it all stands as a warning to those who joined
crowded trades in richly priced stocks, it is good news for
short sellers who are prepared to bet against what they see as
over-valued stocks, and for investors who spend their time
searching for unrecognized gems trading at bargain-basement
It also indicates that the investing world may be returning
to more normal rules, that includes sharper assessments of the
risk in different sectors, now that the Federal Reserve's
bond-buying stimulus program is being reduced and there is less
"easy money" sloshing around.
"The weakness in momentum stocks does have an implication
for the broader market," said Joshua Brown, vice president of
investments at Fusion Analytics in New York. "The best way to
gauge general risk appetite is to look at momentum sectors."
NEAR RECORD LEVELS
Investors and strategists stress that the pain in the
momentum area is mostly isolated to that world. The wider stock
market isn't in the crosshairs - and some sectors are benefiting
as money is switched.
"It would normally be concerning to see this," said Frank
Gretz, market analyst at brokerage Wellington Shields & Co in
New York. "Instead, other companies are stepping up and new
leaders are emerging. Enough is holding together that I haven't
given up on the bull market even with the leadership coming
The S&P 500 is within a few percent of record levels
and inflows into equity funds remain positive. Investors have
moved into utilities, financials and telecom stocks.
In Credit Suisse's analysis of the 24 stocks, all but 1 of
the companies derive at least 55 percent of their present value
from their future growth prospects. Essentially, they're big
bets on the future, typical of biotech and IT names.
Some of the stocks have unenviable characteristics.
Servicenow and Incyte are characterized as
"worst in class" by Credit Suisse's proprietary analytical
models - which means they're considered low quality names with
weak price momentum and pricey in value. Others, like Pandora
Media, are considered "momentum traps," that are expensive
and lower-quality, but have strong momentum.
But it's far from certain that such names have a lot further
to fall. The bull market has been resilient, and that has helped
stocks like electric car maker Tesla Motors weather
bouts of weakness as it did in the fall of 2013, when its shares
lost 40 percent before streaking again to new highs.
John Hempton, chief investment officer of Bronte Capital, a
small hedge fund based in Sydney, Australia - who is also a
prominent short seller - said he was loath to say that momentum
"If you go back to dot-com, there were five times it cracked
before it really cracked, and if you shorted each of those
cracks, you got yourself carried out," he said of the Internet
stocks boom in the late 1990s and the bust beginning in 2000.
He did say, however, that he has been shorting a number of
biotechnology names. Other investors, too, have been reducing
their presence in the sector as reflected by a nearly 14 percent
slide in the Nasdaq Biotech index since late February.
"We owned biotechs for the last year and had a wonderful
ride. We sold them because valuations got stretched," said David
Kotok, chairman and chief investment officer at Cumberland
He isn't ready to get back in yet. "Let's induce some fear.
Let's correct some prices. Let people start to question what to
do. Then there's a re-entry time," he said.
WORRIES ABOUT NEWBIES
In the IPO market, investors have been fed a steady diet of
new public offerings from companies yet to turn a profit. More
than 50 IPOs have priced in 2014, and two-thirds of those are
unprofitable, according to Renaissance Capital, an IPO
King Digital is actually profitable but suffers from
concerns that Candy Crush may be a fad.
"Candy Crush is a reminder that the market sometimes gets
frothy and that this is not free money," said Sam Kendall,
global head of equity capital markets at UBS.
Hempton said he was less concerned about the technology
names coming to market than the biotech shares.
"Everything that I have seen [in tech] is at least plausible
that it could earn money. People are still funding projects that
are real bets," he said. "In biotech at the moment, people are
funding projects because they can sell them to the stock
THE LONG VIEW
Activity from short-sellers indicate that many do not
believe the correction in momentum names has fully shaken out
the group's excess.
The 24 stocks identified by Credit Suisse have seen a slight
increase in short bets in the last week, according to Markit.
This group, on average, shows 18.8 percent of the shares
available for borrowing being used for shorting, up 0.6
percentage points in the last week.
However, some of the names have seen shorts shaken out by
periods in which they rallied. In the early part of 2013, more
than 24 percent of Tesla shares were being shorted. That's been
halved as the stock has rocketed higher, boosting its forward
price-to-earnings ratio to 113.
By most measures, shares are overvalued. But a full-scale
retreat does not seem to be in the cards at this point. Scott
Wallace, chief investment officer at Chicago-based hedge fund
Shorepath Capital, has boosted his position in Facebook
and is looking at biotechs more closely.
"It's periods like these when you should start to think
about great long term franchises and start to add to them," he
said. "I had zero exposure to biotech going into this, and now
I'm doing my homework on a few of them."
(Reporting by Ryan Vlastelica and David Gaffen; Additional
reporting by Nicola Leske, David Randall and Tim McLaughlin;
Editing by Dan Burns, Martin; Howell)