Hedge funds were no doubt affected by the grumbling in the markets in May, with many funds seeing significant losses. But while preliminary results show that June is proving kinder for hedge funds, Mary Ann Bartels, chief market analyst and head of technical analysis at Merrill Lynch, doesn't think that we are out of the woods just yet.
"The market is extremely oversold and there are a lot of shorts, so we can get a short covering rally or a rally from a very over-sold condition," said Bartels, "but we don't think that the corrective process is completed yet and we are still looking at the 15-20% correction that we talked about earlier this year from peak to trough in the S&P500" (FINalternatives 1/13/06).
She added that this number may be closer to 30% for the Nasdaq. Bartels believes that the markets have the ability to rally in the summer, but that changes are afoot for the end of the third quarter. "Seasonally, the weak period starts in September, and then we get an important market low in October."
While most Wall Street pros had been predicting a market correction, saying it was long overdue; it was the hedge funds that were the catalyst for recent events.
"The majority of the correction that we just saw was driven by hedge fund behavior, not by long-only," Bartels said. "We saw a major de-leveraging process from the macro hedge funds of being long international markets, particularly in emerging markets, and short the U.S." Bartels said that another de-leveraging process can happen with U.S. hedge funds because "they have just reached the highest net-long position in equities that we've seen in the history of our work."
But while Bartels views the weather for the near term as overcast, she believes that some sectors will protect investors from the rain better than others.
"In a down market, nothing goes up," she said. "So, on a relative basis, our favorite sector has been and continues to be the telecom sector." She is also fond of select consumer staples and certain utilities, but added that the only thing that won't go down in a down market is cash.
"Holding cash for a short period of time or raising cash for a short period of time is a good thing. You can redeploy that in October and pick up better values in the market," she said.
"Longer-term we are still constructive on the market. We would look for a rally in the fourth quarter and for the markets to make new highs in 2007."