Stocks may be headed for another selloff according to RBC’s ‘hedge fund hot dogs’ basket


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,
+1.35%
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.

See: Hedge funds pile up $125 billion bet against the S&P 500’s big summer rally

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.


Source: RBC

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.


Source: RBC Capital Markets

It’s notable that megacap tech names like Microsoft Corp.
MSFT,
+1.07%,
Alphabet Inc.
GOOG,
+2.59%,
Amazon.com Inc.
AMZN,
+2.53%,
Meta Platforms Inc.
META,
+3.28%,
Apple Inc.
AAPL,
+1.41%
and Tesla Inc.
TSLA,
-0.40%
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.

See: U.S. stocks mostly higher as strong economic data lifts sentiment ahead of Powell speech

While the S&P 500, Dow Jones Industrial Average
DJIA,
+0.94%
and Nasdaq Composite
COMP,
+1.61%
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.

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