If Wall Street Loves Technology Stocks, Why Are Hedge Funds Selling Them?

By Lee Jackson Updated Jun 27, 4:06PM EDT · Published Nov 18, 9:00AM EST

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For much of the past two years, technology has dominated both long/short exposure and long/short performance in the hedge fund world. This has changed over the past quarter with technology dropping from overweight to simply in-line. The Prime Brokerage team at Credit Suisse took a look at the longer history of technology exposure. Net exposure in the United States has dropped to the lowest level since early 2011 despite gross exposure remaining at the highs. This is a startling revelation when almost every major Wall Street firm we cover is bullish on tech for 2014.

There is clear exposure dispersion within the underlying industries, with net exposure to software and services declining far less than the hardware and semiconductor groups. This part of the data tends to fall in line with the Wall Street thought process. Many firms are urging clients to move away from the big technology service stocks like International Business Machines Corp. (NYSE: IBM), Hewlett-Packard Co. (NYSE: HPQ) and even Dell before its buyout. Hewlett-Packard has service exposure from its purchase of EDS. Dell has exposure from its 2009 purchase of Perot Systems. Hedge funds, as the data indicates, are selling these stocks less than the hardware and chip stocks, but they are selling.

Despite being a gigantic holding in Warren Buffett’s portfolio, IBM has experienced pricing issues within its service business. The company has also had a very difficult time implementing its cloud strategy, which is crucial to further earnings growth. Hewlett-Packard has had a tremendous run in the past year and remains a solid candidate for hedge funds to sell. The stock has doubled off its lows posted this time last year, and it looks to be rolling over on the chart.

This news is important for investors looking for ideas for next year after an outstanding 2013. With long/short hedge funds now taking the performance lead for 2013 away from the event-driven category, it is helpful to have a glimpse at what the hedge fund portfolio managers are doing. HFR reporting indicates that the hedge fund industry saw $23 billion in net new inflows in the third quarter. That is the most money piling in to hedge funds since the fall of 2011. Much of that new money is going into long/short hedge funds. If they are selling some of their tech holdings, should our readers be doing the same?

It is very possible that the hedge funds are moving holdings that are part of what is called a “crowded trade.” That is hedge fund speak for stocks that everybody tends to own at the same time. The hedge fund world is a very “monkey see, monkey do” world. Once a trade that begins to work gets around, they all start to put it on. Often the stocks involved are momentum names. These are stocks that tend to trade higher despite not having solid fundamentals like reasonable price-to-earnings ratios and other similar metrics.

Momentum stocks that have been part of the crowded hedge fund trading are names like Netflix Inc. (NASDAQ: NFLX), Amazon.com Inc. (NASDAQ: AMZN), Priceline.com Inc. (NASDAQ: PCLN), Baidu Inc (NASDAQ: BIDU) and LinkedIn Corp. (NYSE: LNKD). Here are some details on each:

Netflix has had an incredible run over the past two years. Investors have applauded its move into programming and viewers have been very positive on the programming as well. Shares trade at astronomical levels, enough for activist investor Carl Icahn to walk on much of the position.
Amazon is much more than just the number one online retailer. It is the top provider of public cloud hosting and is expected to continue to lead that category for some time to come. Still, this is a mature Internet story, trading at sky-high multiples, and a company that refuses to show any operating margins as it aims for dominance in 2016 to 2020.
Priceline’s ascendance into the $1,000 category has not only made it pricey, the company has stretched the valuation limits to the max. Trading at well over 30 times earnings, most hedge funds have been inclined to take their gains and move to more reasonable valuation waters. At one point no too long ago, Priceline was worth more than all the major airlines.
Baidu is another name that may well be getting sold on a valuation basis. The Chinese Internet search provider now trades at close to 34 times earnings. The stock also has almost doubled in price since taking off last July. The “Google of China” has a dominant position, but other local players have been trying to take market share.
LinkedIn is a favorite destination for those looking to have a better professional presence when documenting their career and resume. While dominant in that part of the Internet social media area, the stock is overbought and is a likely candidate to be sold by hedge funds. This is another one with astronomical valuations on sales and earnings multiples.

So what are investors to do if hedge funds are starting to sell their technology stocks? Unless you have gigantic gains that should be harvested, perhaps nothing. Technology stocks for the most part are very reasonably priced, compared to some other sectors of the market. Rotating away from the service sector to areas facing less competition might be a solid move. Big data, cyber security, flash storage, and public cloud hosting are all red-hot areas that are growing fast.

A good rule of thumb for all investors may be the simplest of all Wall Street rules: No one ever went broke taking a profit. As the year starts to wind down, go through your portfolio and sell at least half of any big winner. Redeploy those gains into stocks that are reasonably valued and are in good position to benefit from next year’s expected improving growth outlook. With growth expected to jump to 3.7% next year from 2.8% this year, cyclical names leveraged to capital spending growth may be poised to shine.

About the Author Lee Jackson →

Lee Jackson has covered Wall Street analysts' equity and debt research and equity strategy daily for 24/7 Wall St. since 2012. His broad and diverse career, which included a stint as the creative services director at the NBC affiliate in Austin, Texas, gives him unique insight into the financial industry and world.

Lee Jackson's journey in the financial industry spans over 30 years, with nearly two decades as an institutional equity salesperson at Bear Stearns, Lehman Brothers, and Morgan Stanley. His career was marked by his presence on the sell side during pivotal Wall Street events, from the dot.com rise and bubble to the Long Term Capital Management debacle, 9/11, and the Great Recession of 2008. This is a testament to his resilience and adaptability in the face of market volatility.

Lee Jackson’s practical financial industry experience, acquired from a career at some of the biggest banks and brokerage firms, is complemented by a lifetime of writing on various platforms. This unique combination allows him to shed light on the intricacies and workings of Wall Street in a way that only someone with deep insider experience and knowledge can. Moreover, his extensive network across Wall Street continues to provide direct access for him and 24/7 Wall St., a privilege few firms enjoy.

Since 2012, Jackson’s work for 24/7 Wall St. has been featured in Barron’s, Yahoo Finance, MarketWatch, Business Insider, TradingView, Real Money, The Street, Seeking Alpha, Benzinga, and other media outlets. He attended the prestigious Cranbrook Schools in Bloomfield Hills, Michigan, and has a degree in broadcasting from the Specs Howard School of Media Arts.