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

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
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.
Alphabet Inc.
+2.59%, Inc.
Meta Platforms Inc.
Apple Inc.
and Tesla Inc.
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
and Nasdaq Composite
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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