Don’t Curse The Dark, Buy Hedge Funds

Seventeenth century theologian Thomas Fuller started a meme when he wrote “It is always darkest just before the Day dawneth.” Reverend Fuller could have been a stock analyst, for even in the deepest of funks, a stock’s prospects could be bright.
 
Let’s focus on the condition “could be.” Sure, the fundamentals have to be right, but a stock needs to be at a technical inflection point for a rebound. Chart patterns matter.
 
That’s why the price action in the JPMorgan Diversified Alternative ETF (NYSE Arca: JPHF) caught my eye. Take a look:

See the activity within the two red lines? That pattern is known as a “falling wedge.” It’s a classic reversal formation. In this case, it lays a technical foundation for a bullish breakout. Breakouts from such wedge patterns are much more likely, i.e., about 70 percent, to be to the upside. And, on a breakout, the average price rise is better than 30 percent, though longer bullish trends are not uncommon.
 
But let’s not get ahead of ourselves here. Just what the heck is JPHF? The answer’s embedded in the exchange-traded fund’s ticker symbol. ‘HF’ stands for ‘hedge fund.’ The fund is an actively managed portfolio that allocates between three common hedge fund strategies: equity long/short, event-driven and global macro plays. The ETF doesn’t hold hedge funds themselves; the portfolio runners employ a rules-based stock selection approach to build exposures to the tactics.
 
Inasmuch as JPHF adheres to hedge fund strategies, you’d be right to assume hedge funds haven’t been faring well.  Equity hedge fund strategies tracked by Hedge Fund Research, Inc. gained only 1.9 percent for the year through July. The S&P 500, in contrast, appreciated 5.3 percent. Event-driven strategies rose 2.5 percent according to HFRI while global macro funds lost 2.1 percent.
 
So, does the falling wedge portend a reversal in hedge funds’ fate?  Well, the chart’s telling us the odds for THIS particular portfolio of hedge fund strategies are increasingly favoring an upturn. Should the fund’s price break through the upper red line, we should expect traders to jump in on the long side. Their proclivity will, in large part, be boosted by any wobbles in beta trades, i.e., index hugging. And, in smaller part, on hope. For them, the words of American author Anne Lamott will likely be top of mind: “Hope begins in the dark.”