By Svea Herbst-Bayliss
BOSTON (Reuters) - Some of Wall Street's biggest names are licking their wounds as October lives up to its reputation as one of the market's roughest months.
The Standard & Poor's 500 index has now lost almost 8 percent in the past three-and-a-half weeks , wiping out almost all of the gains achieved earlier in 2014. What seemed like another good year for investors in U.S. equities is now fraught with uncertainty, with $1.3 trillion in S&P companies' market value disappearing. Add in the impact of an oil price slump plus a big surprise rally in U.S. Treasuries, and the risks of big investment losses have risen dramatically.
From top equity strategists to big hedge funds and mutual funds, the carnage has spared few. Morgan Stanley strategists said this week that their model portfolio through Monday had trailed the S&P by 3.6 percentage points due to bad bets on technology stocks, including GT Advanced Technologies, the Apple supplier that surprised investors with a bankruptcy filing last week.
Billionaire investor Carl Icahn, had indicated for some time that he was prepared for a stock market reversal but it is unclear whether he would have been fully hedged against a 27 percent drop in the shares of online video company Netflix on Wednesday after it reported slower U.S. growth. Icahn's Icahn Enterprises owned 1.8 million shares at the end of the second quarter. He could not be immediately reached for comment.
The average U.S. equity mutual fund through Tuesday was down 2.3 percent on the year, according to Morningstar data, trailing the S&P, which is up a meager 0.8 percent. Meanwhile, leveraged ETFs, which try to double the performance of key averages, are doing worse – a popular leveraged bond ETF that bets on higher long-dated yields has lost 16 percent in the last 20 days. The Proshares Ultra S&P 500 fund – an ETF that looks to double the S&P's performance – is down 14 percent in 19 days.
Top equity strategists at major investment banks polled this year by Reuters have also been caught wrong-footed. They steadily boosted their bets on the rally continuing. The median S&P 500 year-end forecast has been steadily climbing, from a median of 1,925 in December 2013, to 2,000 in June, and then 2,033 in a Sept. 25 poll.
FEAR TOMORROW
Still, some investors fear there is a lot worse to come – and this time they are concerned that the U.S. Federal Reserve won't be in a position to stem the selloff as it has done in recent years. The Fed is likely to be reluctant to engage in more quantitative easing, the pumping of money into the financial system through bond purchases."I fear tomorrow could be worse," said James Sanford, portfolio manager at SAG Harbor Advisors, adding that "while we haven't seen the swings we saw in 2011, some of the problems we had at that time are still with us and this time the cavalry in the form of the Fed isn't coming to save us."
To be sure, after a five-year bull market on Wall Street, many big-name investors cautioned that a pullback was long overdue. But the suddenness of the move has been an awakening for fund managers and strategists, many of whom had doubled down on their bullishness as the year wore on, steadily increasing bets on more gains in equities.
One of those was Dan Greenhaus, strategist at brokerage BTIG LLC, who lamented in a note on Tuesday evening that he was one of the Street's last strategists to raise his S&P year-end target – to 2,100 on September 18, just before the market took a turn for the worse.
Greenhaus had expected weakness in equities at some point, but by September bought into the thesis that underperforming hedge funds would buy into the advance, leading to a "catch-up" trade. Greenhaus did not return calls seeking comment.
However, many hedge funds have run for cover at the first sign of trouble, adding to the sell-off's speed and intensity.
They've responded by exiting largely popular trades, particularly in energy stocks, that had become losers. Hedge fund favorite Cheniere Energy Inc tumbled 14.5 percent in five days, and Anadarko Petroleum Corp, another stock widely held by hedge funds, dropped 12.8 percent. Drugs company Gilead Sciences Inc, also popular with hedge funds, has lost 12.6 percent in five days.
And then there are losses associated with failed deals including news that AbbVie is reconsidering its bid for biotech company Shire, possibly dealing a fresh blow to hedge fund titan John Paulson, who had a big bet on Shire and publicly praised the deal only a few weeks ago.
Shire's value plunged more than 20 percent on Wednesday from around $49 billion to $39 billion, potentially wiping around $500 million from the value of Paulson's stake and $270 million off Elliott Management's stake, according to Reuters calculations.
Credit Suisse Prime Services data show that hedge funds' most popular long positions fell 8.6 percent during the first nine days of October, compared with a 5 percent drop for the S&P 500.
The bankruptcy of GT Advanced, which had a contract to supply Apple with sapphire glass, had a negative knock-on impact for many stocks, hedge fund managers say. Among its shareholders at the end of the second quarter were mutual fund giant Fidelity and many hedge funds including Whitebox, Highbridge Capital Management and Citadel.
"Hedge funds are getting crushed right now," said Peter Rup, CEO and chief investment officer at Artemis Wealth Advisors, which advises high net-worth families and foundations. "They are notoriously bad at market turns and it is going to be a horrible month. They got a little lazy and didn't take preventative measures in time."
Morgan Stanley chief equity strategist Adam Parker had also included GT in his list of favored stocks. His portfolio included a 1 percent allocation to GT. "Please forgive us," Parker wrote Tuesday of his bet on the stock, which has lost 93 percent of its value this year.
Parker noted that his basket of stocks has trailed the S&P 500 through Oct. 13 by 3.6 percentage points due to weak stock selection in technology and financials and an overweighting in the consumer discretionary area. Recently added positions in stocks like software company VMware and casino company Las Vegas Sands have disappointed.
Parker was not available for comment. His note points out that the portfolio has outperformed the S&P by 6.7 percentage points since the beginning of 2011.
SOME BOND BETS SUCCEED
As anxiety about tumbling stocks spread, yields on the 10-year U.S. government bond dropped below 2 percent on Wednesday for the first time since mid-2013, underscoring just how nervous investors are.
Risky leveraged exchange-traded funds that bet on rising bond yields clocked steep losses with the Proshares UltraShort 20+ year Treasury ETF losing 1.6 percent. The ETF has lost 16 percent in the last 20 trading days.
Michael Landreville, who runs the Thrivent Government Bond Fund, braced for higher interest rates long ago and stocked his fund with bonds maturing years from now. But in light of the current market dislocation, he plans to shorten his duration. The fund lost 0.82 percent in September, but is up 3.38 percent on the year, according to Thrivent's web site.
Low yields have rewarded bond fund managers who positioned their funds with long durations - that is, bonds whose prices rise more as yields fall - in 2014.
One is the $238 million Wasatch-Hoisington U.S. Treasury Fund. Portfolio Manager Van Hoisington said he saw no signs of higher rates at the start of the year given high worldwide debt levels.
"We felt the possibility of rising inflation was miniscule," he said. The fund has kept its effective duration around 20 years, helping it return 25.8 percent through Oct. 14. That beat 83 percent of its peers, according to Morningstar data, far above the 5.58 percent return for the Barclays U.S. Aggregate Bond index, which currently has a duration of 5.63 years.
And not everyone was overly optimistic on equities. David Joy, chief market strategist at Ameriprise Financial in Boston, put a year-end target of 1,845 on the S&P 500, expecting weakness as the Fed backed away from its stimulus. However, he hadn't expected more of a decline than this – and is now questioning whether he has been bearish enough.
"Now the wild card is, instead of talking about accelerating growth, we're talking about importing weakness from overseas, and I think this is more problematic for the market," he said.
(With additional reporting by Ross Kerber in Boston, Jennifer Ablan, Daniel Bases, David Gaffen, Richard Leong and Caroline Valetkevitch in New York; Editing by David Gaffen and Martin Howell)
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