Hedge funds just made a big mistake on tech stocks

• Hedge funds and other large speculators made a poorly-timed decision to go net short tech stocks for the first time in 21 months.
• The tech-heavy Nasdaq 100 index surged 5.6% during the week in question.

Everyone reacted to the stock market‘s recent correction in their own special way.

Some investors rushed to protect their holdings, pushing hedging costs to a 14-month high. Others piled back into the flaming wreckage of the short-volatility trade.

Hedge funds, meanwhile, turned their backs on tech stocks. As of last week, they had a net short position on the tech-heavy Nasdaq 100 index for the first time in 21 months, according to Commodity Futures Trading Commission data compiled by Bloomberg. It also makes them the most negative on tech stocks since 2011.

And that would be all well and good, except the bearish shift came as tech stocks surged 5.6%, their best weekly performance since October 2014. It was unfortunate timing for hedge funds and other large speculators, who were net bullish on tech for 62 straight weeks without enjoying an increase of that size.

It’s worth noting this could be a very brief foray into short territory if hedge funds see recent tech strength as a reason to “cover” their positions — or close them through purchases. That would not only push the likes of the Nasdaq 100 even higher, but could also re-orient large speculators as net buyers once again.

And as the dust settles following the equity blow-up earlier this month, there’s a lot to be excited about in the US market, especially when it comes to tech. Companies in the industry are expecting to see earnings growth of 31% for the full year 2018, which is 10 full basis points more than the benchmark S&P 500.

Since profit expansion has been a long-running pillar of the nearly nine-year bull market, these forecasts would suggest hedge funds are better off being long tech. And if that change leaves them seeking hedges, Morgan Stanley has some alternative ideas for downside protection.