A group of the most popular stocks owned by the world’s largest hedge funds are starting to underperform the broader market once again. According to a team of analysts at RBC Capital Markets, this is a sign that U.S. stocks could be headed for another blowup.
For several years now, a team of equity analysts led by Lori Calvasina, RBC’s head of U.S. equity strategy, has been tracking a basket of what it calls the “hedge fund hot dogs” — the most popular S&P 500 SPX, +1.41% stocks owned by 300 of the world’s largest hedge funds. The analysts update the basket four times a year after hedge funds release the breakdown of their end-of-quarter equity holdings.
Since it created the basket, the team has noticed a pattern: when the “hedge fund hot dogs” start to underperform an equal-weighted version of the S&P 500, it’s often a sign that a broad-based selloff in stocks was in store.
It happened in 2018, when the basket started to underperform about a month before the selloff in the fourth quarter of that year. And after a brief period of stabilization over this summer, the “hot dogs” are underperforming once again.
The indicator has worked in the other direction as well: Calvasina and her team explained that “hot dog” outperformance in April and May made them optimistic that a near-term bottom might be approaching.
The chart below depicts the performance of the ‘hedge fund hot dogs’ basket relative to the equal-weighted S&P 500 index.
Over the past couple of weeks, the basket has started to underperform once again.
“The weakness of this basket so far in 3Q22, when just 25% of the names on this list have outperformed the S&P 500, is something we are keeping a close eye on as it may be signaling that stocks generally are poised to experience another bout of volatility in coming months,” the team wrote.
Here’s a breakdown of the basket’s constituents ranked by aggregate dollar value owned by the 300 funds tracker by RBC.
It’s notable that megacap tech names like Microsoft Corp. MSFT, +1.11%, Alphabet Inc. GOOG, +2.62%, Amazon.com Inc. AMZN, +2.60%, Meta Platforms Inc. META, +3.38%, Apple Inc. AAPL, +1.49% and Tesla Inc. TSLA, -0.35% are among the biggest constituents of the basket.
Many of these are the same stocks that led the market higher for much of the past decade through the S&P 500’s record high reached in January.
They also lead the market lower during the historic selloff that followed during the first half of the year.
While the S&P 500, Dow Jones Industrial Average DJIA, +0.98% and Nasdaq Composite COMP, +1.67% were each on track to close higher Thursday, all three benchmarks remained mired in the red for the week. If the S&P 500 and Nasdaq were to Friday’s session at these levels, it would mark their second consecutive week in the red.