Hedge Funds May Drive Year-End Nasdaq Rally

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Despite the Dow's recent historic highs, this rally has been driven by the Nasdaq. From its bottom on July 21st at 2,020.29 to its closing price of 2,454.84 yesterday, the Nasdaq has gained more than 21.5%. Similarly, from the Dow and the S&P 500's lows of 10,706.14 and 1,223.69 on June 13th, each index has rallied only about 15.1% and 14.6%, respectively.

Low Date Gain Since Low YTD Gain
Nasdaq 7/21 21.5% 11.3%
Dow 6/13 15.1% 14.9%
S&P 500 6/13 14.6% 12.4%

Still, the Nasdaq is trailing both the Dow and the S&P in YTD gain, which leads me to believe that there may still be room to run for the Nasdaq.

Further fueling my belief is the fact that many of the top hedge funds are actually underweight technology compared to the S&P 500. According to data posted by Ticker Sense, it appears that the top 50 hedge funds are substantially underweight technology stocks compared to the S&P. Further, sectors like consumer discretionary, consumer staples, and telecom are substantially overweighted.

In addition to the underweighted status of tech stocks in many portfolios, the fact that many hedge funds are struggling to keep pace with the market fuels the possibility of future gains. As noted in today's WSJ, the average long/short hedge fund is up a mere 9.2% YTD. Vastly underperforming the markets, many fund managers may begin to feel the squeeze as they rush to outperform the market and justify their lofty fees. If this happens, it's possible that we could see a swift move out of the sluggish consumer discretionary plays into many of the already-hot tech names.

When I last wrote about the Nasdaq a few weeks ago, I was watching to see if we could break through the prior high around 2,375. Soon after, the market broke through resistance and flew more than 80 points above its previous multi-year high. Even though the market may be getting a bit extended, this rally has been relentless in the fact that there have been very few opportunities to buy in during sell-offs. As long as that type of buying pressure continues, we could be setting up for another push higher as hedge funds leave the consumer discretionary plays and jump into tech.